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FHA Mortgages for Bad Credit: What You Need to Know
Wondering if FHA loans for bad credit exist? Or, if there are bad credit home loans in general? Today might be your lucky day.
If you’re looking to buy your first house, then it’s likely you’ll be considering an FHA loan, which is ideal for first-time homebuyers. When buying a home, the lender or bank will want to make sure you meet certain requirements, including a good credit score. However, if your credit is not in great shape (or is just plain bad), then you might be wondering if you’ll qualify for an FHA loan.
While it may be difficult, there are circumstances in which you can get a home loan, even with bad credit. FHA loans for bad credit are possible to obtain if you know how.
What is an FHA loan?
An FHA loan is a mortgage loan backed by the Federal Housing Administration. The FHA doesn’t act as the lender, though. The government agency simply backs the loans and private lenders offer them to borrowers. The goal of these loans is to make home-buying more accessible to buyers with average incomes or credit scores.
This is achieved by having less stringent lending parameters and other flexible requirements. An FHA loan generally allows borrowers to put down 3.5% as a down payment on a 30-year loan. Borrowers will have to meet the requirements for this type of financing, but it’s less difficult than it would be with a conventional loan.
This carves an easier home buying path than other types of mortgages, which would likely require you to put down between 5% to 20% for approval. Coming up with 3.5% on a lower income is a lot easier than finding 20% down in the budget — especially if funds are stretched.
Another perk is that borrowers with poor credit scores may still be approved for a loan if they are able to put more money down on the home purchase. Interest rates on FHA loans are also extremely low, making this type of loan appealing to first time home buyers.
Types of FHA loans
There are several types of FHA loans that borrowers can take advantage of. The loan types vary based on the type of interest rate, the type of property you’re buying and other factors.
The FHA loan options include:
FHA purchase loans
This is the “standard” FHA loan that requires borrowers to put 3.5% down and have a minimum of a 580 credit score. If you’ve met the credit score requirement but you’re having difficulty saving for the down payment, there are down payment assistance programs you can explore.
If you do not have at least a 580 credit score, some lenders may still offer you an FHA loan under different terms. For instance, if your credit score ranges from 500 to 579, you may be able to get an FHA loan with 10% down — as long as you meet the other requirements.
FHA 203(k) loans
If you’re looking to put in some elbow grease into your new home to save money and gain equity, you can buy or refinance a fixer-upper home with an FHA 203(k) loan. This loan allows you to roll the costs of the improvements and construction into the mortgage so you’re able to make updates and buy your home with one loan and monthly payment.
FHA rate and term refinance loans
If you already own a home and you want to refinance now that mortgage rates are extremely low, this type of loan would be a good option. These loans help homeowners refinance up to 97.75% of a home’s value. You also have the option of rolling the refinance closing costs into the loan as well.
[ More: The Guide to FHA Mortgage Refinancing ]
FHA cash-out refinance loans
As homes appreciate in value and as you pay your home loan down, you gain equity. Equity is basically the percentage of the home you own. If you want to be able to utilize that equity, you can do so with an FHA cash-out refinance loan. This will allow you to tap into up to 80% of your home’s equity.
Why an FHA loan is a good option for bad credit
An FHA loan can be a good option for bad credit, especially compared to other types of mortgage loans. But what constitutes bad credit? It depends on who you ask. According to credit monitoring bureaus like Experian, anything below 670 is technically considered bad. More specifically, those between 580 and 669 are fair, while those between 300 and 579 are poor.
You can still apply for an FHA with a score between 500 and 579, though, which means you can technically get an FHA loan, even with bad or poor credit. This may not be as easy as it seems, though. Other factors are at play aside from your credit score, so it’s worth discussing your options with a mortgage lender.
Those loans are great for bad credit when compared to other types of loans, in major part because conventional loans require higher down payments, better overall financial profiles and private mortgage insurance. Those stricter barriers can put conventional loans out of reach for a lot of people.
Getting an FHA loan
To get an FHA loan, you should have at least a 500 credit score, though 580 or higher is going to be easier for approval.
The other requirements include:
- Verifiable employment history for the last two years
- Financial documents including pay stubs, federal tax returns and/or bank statements
- Must be used as a private residence
- Must be approved by an FHA-approved appraiser
- Debt-to-income ratio cannot exceed 43% of your gross monthly income in most cases
- Payments should not exceed 31% of your gross monthly income in most cases
- A 3.5% down payment
If you meet most of these requirements but you have a credit score under 580, you may still be eligible for an FHA loan with a higher down payment.
Once you’re sure that you’ve met the basic requirements, it’s time to start the process of getting an FHA loan.
To get approved:
- Talk to a lender. Real estate agents can connect you to the lenders they use, or you can go through companies like Quicken Loans, Rocket Mortgage, or HomeLight.
- Provide all proof and documents about income and meet other requirements.
- Wait to have your credit score run by the lender. If everything checks out, you’ll get pre-approved and have an idea of your maximum spending amount and interest rate.
- Shop for homes within your pre-approval parameters.
- Once you find a home and have a contract on a home, you’ll finish up the loan process. What this looks like will depend on your lender, but in most cases, you’ll need to present additional documents to your lender, including bank statements, W2s, tax returns, etc. They’ll advise you on what they need to see for final approval.
Other ways to get a mortgage with bad credit
If you are not able to meet the basic requirements for an FHA loan, it could be a good idea to take some time to pay off debt and get your credit score in shape.
[ Read: Tips for Getting Your First Mortgage ]
That said, there are ways to get a bad credit mortgage loan if you’re not able to qualify for an FHA loan. You can shop around for a lender that’s willing to offer you a conventional loan. However, FHA generally has the most flexible requirements, so keep that in mind. If a lender offers you a conventional loan, but you will likely pay for it with a high interest rate, fees or other expensive charges.
If you live in a rural area, you may be able to get a USDA loan, for example. These loans are affordable and obtainable for lower-income buyers, but you’ll have to meet the restrictions to obtain one.
You may qualify for a VA loan if you’ve served in the military. These loans also have lower credit requirements and don’t require a down payment, which could help you get approved if you’re struggling to get an FHA loan.
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