The mortgage industry continues to raise its credit standards in acceptance of loans to fund. Lenders do this to prevent foreclosures, and to keep their doors open for business. Although credit guidelines have been tightened and higher credit scores are becoming the new requirement, there are ways that you can still get financed with lower credit scores.
Contact a mortgage broker about purchasing a home. Inform him that your credit scores are in the 580 range. He will explain that the Federal Housing Authority (FHA) is an insurer of mortgage loans which promotes affordable housing and very low down payments. FHA loans have looser guidelines than other types of loans, and a few FHA lenders will still fund a purchase loan with a lower credit score. If the broker cannot provide information, you should contact a different brokerage. Some lenders will fund borrowers with lower credit scores.
Provide proof of income for at least two years. You--and your spouse, if you are married--will have to qualify for the loan without a co-borrower. Although the FHA allows non-occupying co-borrowers on loans to help borrowers qualify for home loans, the lender will not allow this practice when credit scores are very low.
Complete the loan application. Provide proof that you have enough funds for a down payment, insurance, and escrow costs. The FHA requires 3.5 percent of the purchase price of the home.
Calculate the required down payment amount. Multiply the sale price by the percent required. For example, if the home costs $200,000, then multiply $200,000 X 3.5%=$7,000. The new base loan amount would be $193,000.
FHA has two types of mortgage insurance premiums (mip) that must be added. The first type is normally added to the loan and is calculated at $193,000+2.25%($4342.50)=$197,342.50. New loan amount would be $197,300. The odd $42.50 would be added to closing costs.
Calculate the second type of mortgage insurance premium (mip) at $197,300X.55%=$1085.15/12=$90.43 to be added to your monthly payment each month. Now that we have a correct loan amount and monthly mip add on, we can calculate the estimated payment. $197,300 at 6% over 30 years would result in a $1182.91 monthly payment, but you must add $90.43, plus estimated yearly taxes of $1800/12=$150 and estimated yearly insurance of $1200/12=$100=$1523.34 grand total monthly payment. Now that we have a total monthly (estimated payment) we can prequalify the borrower.
Understand that FHA allows for 31 percent of gross income for the housing payment, with no more than 43 percent of gross income for all monthly debts. Let's say the borrowers earn $5,000 per month and the monthly payments are $400 per month. The new payment of $1523.34 divided by $5000=30.46%. The total of $1523.34 +$400=$1923.34 divided by $5,000=38.46%. These debt ratios are lower than the maximum ceilings of debt ratios for FHA, so this is acceptable.
There may be lender restrictions with the lower scores. An example may be that the lender may limit how much a seller can contribute to closing costs. They may require that the borrower have some reserves--amount of two to three months of monthly payments--in savings after closing the loan. Your broker will give you specific details on what is required. This may vary from lender to lender.
- FHA does not fund loans; it only insures them. FHA sets up the guidelines for writing and insuring the loan, but it is the lenders who set up score requirements. This is why some lenders require 640 mid score for approval while others can fund an FHA loan as low at 580. Some lenders can only fund when the file has been approved (underwritten) through the DU system (automated underwriting). They may not offer "manual underwriting" which is where a file is approved by a person rather than the DU system. Scores as low as 580 would not be instantly approved through the DU system, so a manual underwriting becomes necessary.
- Higher credit scores are rewarded with a lower mip of 1.75 percent. Monthly MIP can range from .50 percent to .55 percent.
- Zillow.com: FHA Loans
- Empirepub.com: New FHA Risk Based Mortgage Insurance
- Joey Campbell, Christensen Financial Corp., Florida
- Comstock/Comstock/Getty Images