We’ve spent the last few days querying mortgage lenders about their credit score requirements for FHA loans. Specifically, we asked lenders if they expect to make any major changes next year, as far as credit scores are concerned. As it turns out, FHA credit score requirements in 2014 will be much the same as they were in 2013.
Most lenders said borrowers will need a score of 620 or higher to qualify for an FHA-insured mortgage loan. A handful said they would likely set the bar at 640 next year. A few lenders said they would go down to 600, if the borrower had other “compensating factors” like significant cash reserves, or a long history of making mortgage payments on time.
620 and 640 Are the ‘Magic Numbers’ for Many Lenders
We have conducted a number of informal surveys and questionnaires in recent weeks, to get a better understanding of the FHA credit score requirements we might see in 2014. After speaking to more than two-dozen lenders that participate in this program, we have learned the following.
Most lenders said they would use either 620 or 640 as their minimum credit score requirement for FHA loans in 2014. It’s important to note that these numbers are far above the official HUD minimum of 500. See the “overlays” section below to learn more about this distinction.
A few mortgage lenders said they would be willing to go down to 600 for borrowers who have certain compensating factors, such as a larger-than-average down payment. But the 3.5% down payment option is the primary draw of this particular program, so there probably aren’t many FHA borrowers who are willing and able to put down, say, 10% of the purchase price.
Overlays: Why the Official FHA Minimums Don’t Mean Much
Here’s an important takeaway from this article. Credit score requirements for FHA loans can be imposed by two parties. The Department of Housing and Urban Development (HUD) sets the official guidelines and standards for the mortgage insurance program. Their minimum credit standards can be found in Chapter 4, Section A of HUD Handbook 4155.1, and are shown below.
- 499 or below: Not eligible for the FHA loan program
- 500 – 579: Eligible for the program, but must make a down payment of 10%
- 580 or higher: Eligible for the 3.5% down-payment option
Mortgage lenders can set their own score requirements as well, and those may be higher / stricter than the official government guidelines listed above. When we have “standards on top of standards” like this, it is referred to as an overlay. These overlays can vary from one lender to the next.
Here’s a realistic scenario that illustrates (A) the difference between HUD requirements and overlays, and (B) the threshold variance from lender to lender:
John has a credit score of 615. This puts him above the minimum requirement for an FHA loan, as far as HUD is concerned. So he applies for a government-backed loan through ABC Mortgage Company. But this particular lender has a credit score cutoff of 640 for the government-insured loans they originate. So they deny John’s application. Undeterred, John re-applies through 123 Loan Company. This lender sets the bar at 620 for FHA loans, but they’re also willing to consider compensating factors. They evaluate John as a “whole borrower” and decide he represents an acceptable level of risk. So they approve the loan.
Credit Scores One of Several Requirements for FHA Loans
In 2014, many would-be borrowers will be denied financing due to the minimum credit score requirements for FHA loans. But that’s only one obstacle that can trip up borrowers. There are others, as well.
For instance, a borrower with a score of 700 (high above the minimum used by most lenders) might still be denied an FHA loan if he or she carries too much debt in relation to gross monthly income. This debt-to-income ratio / DTI, as it’s known, can be a deal breaker on its own. The same goes for borrowers who cannot prove the source of their down payment funds, or those who lack documentation in other areas. Sometimes it’s a single factor that determines loan approval versus rejection. But it can also be a combination of factors.
Government-Backed Mortgages to Remain Popular in 2014
FHA loans have risen in popularity since the housing market crashed. Borrowers who have a tough time qualifying for conventional or “regular” home loans often turn to the FHA program, with its more flexible requirements for credit scores, debt ratios, and down payments.
First-time home buyers, in particular, flock to this program. In 2012, more than 70% of all FHA purchase loans originated went to first-time buyers. We expect to see similar trends in 2014.
It’s the government insurance that makes this program unique. Lenders who offer these loans receive insurance backing from the federal government, via the Federal Housing Administration (FHA). So if the borrower fails to repay, the lender is covered for losses.
This insurance coverage directly relates to FHA credit score requirements in 2014. As as result of this added protection, lenders are typically more flexible with their approval guidelines. A borrower who falls a little below the bar for a conventional home loan might still be able to qualify for the Federal Housing Administration’s loan program. Think of it as a fallback for the marginally qualified.
According to a Wall Street Journal article from October 17, 2013:
“Home buyers who get mortgages backed by the Federal Housing Administration, which require a small down payment, have lower credit scores—694 on average—than those who get [conventional] mortgages backed by Fannie Mae or Freddie Mac,whose credit scores average 758.”
This is not to say that you need a score of 694 or higher to qualify for an FHA loan. It simply shows that, on average, borrowers who use the government-backed mortgage program have lower credit numbers than those who use conventional financing. This is only logical, since the FHA program is often a last resort for borrowers who can’t qualify for conventional loans.
Disclaimer: This article provides an overview of FHA credit score requirements in 2014. Every lending scenario is different, because every borrower is different. There are exceptions to many of the general rules mentioned above. Borrowers who have scores below the thresholds explained in this article should not assume they are unqualified. The only way to find out for sure is to apply for a loan through an FHA-approved lender. You can find a list of such lenders on the HUD.gov website.