- Most FHA loans today go to borrowers with 700+ credit scores.
- FHA wants lenders to expand borrower eligibility by cutting credit qualifications
- Lenders fear liability if many of their borrowers default.
FHA Pushes Lenders to Lower Credit Qualifications on FHA Loans.
According to a recent report in the National Mortgage News, the Federal Housing Administration wants FHA lenders to loosen minimum credit qualifications on FHA loans. According to the FHA, more than 90% of all FHA loans are for credit scores 680 and above, and the National Mortgage News reported the average credit score for an FHA loan is 700.
Lenders are reluctant to relax credit qualifications because they are afraid that if too many of their borrowers default, they will be put on a “watch list” and prevented from making future FHA loans. Worse, a high loss record will require the lender to underwrite all future losses on its FHA loans.
The monitoring system, called Neighborhood Watch, was put into place in the 1990s to prevent predatory lenders from targeting low- and moderate-income borrowers. A lender writing many loans that default is an indication of a predatory lender, or a lender with lax underwriting standards. The system gives anyone the ability to identify and analyze patterns, by geographic area or originating lender, in loans 90 days delinquent during their first two years.
FHA Mortgage Insurance at a Glance
In comparison to non-FHA loans, FHA mortgages allow low down payments, refinances without appraisal, and low interest rates. FHA loans come at a cost, however — FHA mortgage insurance is costly. Before we go any further, we need to explain how FHA mortgages work.
The FHA is not an investor or lender, nor is it like Fannie Mae or Freddie Mac and buys mortgages from loan originators. The FHA is government-sponsored insurance underwriter that insures mortgages for lenders. Banks can lend money at lower rates because the FHA is bearing most, but not all, of the risk for the loan. As mentioned earlier, if the FHA believes that too many of one loan originator's customers default within two years of origination, it can demand indemnification for actual and future loan losses. This demand would more than wipe out whatever profits the lender made from the loan, which is the reason why lenders underwrite FHA loans conservatively. The FHA calls this process “evaluating counterparty risk.”
Although the US government is the underwriter, any losses are paid from a reserve paid for by premiums provided by FHA-insured homeowners. Today, FHA borrowers pay two forms of insurance: Upfront Mortgage Insurance Premiums (UFMIP), and Annual Mortgage Insurance Premiums (MIP).
UFMIP is 1% of a loan’s amount, is paid once, and is added to the balance of the loan. However, the 1% UFMIP is not included in the loan-to-valuation (LTV) calculation for the purposes of determining a down payment.
MIP is paid monthly, and the amount varies according to the loan’s term and down payment. Here are the FHA's MIP amounts:
- 15-year & LTV >90%: 0.50% annual MIP
- 15-year & LTV <90%: 0.25% annual MIP
- 30-year & LTV >95%: 1.15% annual MIP
- 30-year & LTV <95%: 1.10% annual MIP
MIP goes away when the loan reaches 78% LTV and:
- 30-year term: monthly MIP is paid >60 months.
- 15-year loan term: no 60-month requirement.
The 10 FHA Loan & Credit Qualifications at a Glance
A borrower must meet ten loan and credit qualifications for the FHA to insure a loan:
- Have a valid US Social Security number
- Be a legal U.S. resident (US citizenship is not required)
- Be at or above the legal age to sign a mortgage per state law (usually 18). There is no maximum age limit.
- Verify income, assets, liabilities, and credit history.
- Purchase a one- to four-unit dwelling.
- Have a “31/43” debt-to-income (DTI) ratio. These ratios may be exceeded with compensation factors. The borrower’s monthly housing costs (mortgage principal and interest, property taxes, and insurance) must be 31% or less of gross monthly income. The borrower must also have enough income to pay housing costs plus all additional monthly debt that combined do not exceed 43%.
- Have an acceptable credit history. Loan officers say a FICO score of 620 is considered the practical cut-off point, although the FHA’s limits are lower. For a chapter 7 bankruptcy, 2 years of "seasoning" after the discharge date is required, and 1 year for a chapter 13.
- Pass an FHA loan appraisal. An FHA-certified appraiser must inspect the property to make sure the home is in good overall condition. Disqualifiers include leaking roof, missing siding, structural defects or damage, bad paint, and so on. The appraiser also sets the value for lending purposes. If the appraised value comes in below the FHA’s LTV requirements, the borrower must bring more money to closing.
- Have an acceptable down payment. The minimum down payment on a home purchase is 3.5%, but this may vary by state. The maximum LTV for a refinance is slightly higher on a straight refinance, but 85% on a cash-out refinance.
- Do not exceed the FHA’s maximum loan amount. The maximum loan amount varies from $271,050 to $625,500 depending on the location of the property. See the Dept. of Housing and Urban Development FHA Mortgage Limits page for an authoritative list of limits for your area.
Home buyers will find FHA loans that are 15 or 30 years in length, and at fixed rates. See the Bills.com FHA loan quote page to receive a no-cost, no-gimmick quote from a pre-screened FHA lender.