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FHA Credit Score Requirements And Guidelines Versus Lender Overlays

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FHA Credit Score Requirements And Guidelines Versus Lender Overlays

This BLOG On FHA Credit Score Requirements And Guidelines Versus Lender Overlays Was UPDATED On August 27th, 2018

FHA Credit Score Requirements And Guidelines Versus Lender Overlays:

FHA Credit Score Requirements have several moving parts and depending what consumer credit scores are, it may affect the debt to income ratio requirements .

  • FHA Loans, unlike other residential mortgage loan programs, limits and sets debt to income ratio requirements dependent on borrower’s credit scores
  • This factor is factored in with the Automated Underwriting System
  • Credit Scores also determine the down payment required on FHA Loans
  • To qualify for a 3.5% down payment home purchase mortgage loan, HUD, the parent of FHA,  requires a minimum credit score of 580
  • Home buyers with credit scores between 500 and 579 can qualify for FHA Loans
  • However, instead of 3.5% down payment, 10% down payment is required for borrowers with credit scores between 500 and 579 credit scores
  • Credit Scores also determines mortgage rates on all loan programs
  • Mortgage Rates on FHA Loans are not as credit score sensitive as it is with conventional loans
  • To get the best mortgage rates on conventional loans, borrowers would need credit scores of at least 740 or higher
  • For every 20 point drop, the conventional mortgage rates will get slightly higher
  • Lenders and creditors in general view higher credit score borrowers as less risk when lending money
  • Lower credit score borrowers as higher risk
  • Since FHA Loans are insured by the Federal Housing Administration against borrower’s default to FHA approved lenders, the credit score risk is limited to FHA approved mortgage lenders
  • So this is the reason why credit scores are not as sensitive on FHA Loans as they are with Conventional Loans
  • To get the best FHA mortgage rates, borrowers would need a 680 credit score
  • Those with credit scores under 640 will get higher mortgage rates
  • Those under 600 credit scores will get the highest mortgage rates and may possibly pay discount points
  • Since the mortgage industry is so highly regulated, high mortgage rates on FHA Loans will not exceed 4.75% on borrowers with credit scores under 600 FICO

Consumers will not see any lenders offer mortgage rates on FHA Loans over 6.0%. Even in the 5.0% mortgage rates is extremely rare. There are mandated maximum caps on how much lenders can charge on FHA Home Loans no matter how low borrowers credit scores are.

FHA Credit Score Requirements And Impact On Debt To Income Ratios

Credit Scores will have an impact on debt to income ratio requirements with FHA insured mortgage loan.

  • FHA Credit Score Requirements for a 3.5% down payment FHA home purchase loan is 580 Credit Scores
  • However, there is a significant difference in qualifying for a FHA Loan with credit score of under 620
  • Just because FHA Credit Score Requirements on a 3.5% down payment home purchase loan is 580 does not mean that any borrowers with a 580 credit score is home free and get a loan approval
  • There are mandatory requirements for borrowers with credit scores under 620 to get an approve/eligible per automated underwriting system
  • First and the most important factor that HUD requires on credit scores under 620 is that the debt to income ratio requirements gets reduced to 43% DTI to get an approve/eligible per automated underwriting system
  • If credit scores are at least at 620 or higher, the back end debt to income ratio requirements to qualify for a FHA Loan gets capped at 46.9% front end and 56.9% back end to get an approve/eligible per automated underwriting system
  • Another issue borrowers with under 620 credit scores may need is verification of rent
  • Verification of rent can only be valid if the renter has paid his monthly rental payments with a check for the past 12 months
  • Or has done a bank wire from their bank account to the landlord’s bank account and has paid timely in the past 12 months
  • No late payments in their monthly rent payments is allowed
  • Cash payments to landlord with a landlord receipt is not valid

What Are Reserves And When Are Reserves Required By Lenders

Borrowers with credit scores under 620 may be required to have one months reserves by the findings of the automated underwriting system.

  • One month reserves is equivalent to one month’s PITI, which is one month principal, interest, taxes, and insurance
  • Reserves cannot be gifted and needs to be borrower’s own funds
  • Reserves do not have to be held in escrow
  • Reserves can just remain in the borrower’s bank account
  • Other assets such as investment accounts and 401k retirement accounts can be used for reserves
  • There is no enforcement of reserves after borrowers close on their home loan

Why Do Lenders Have Different Credit Score Requirements

Not all mortgage lenders have the same FHA Credit Score Requirements.

  • This often confuses many home buyers, especially first time home buyers
  • Even though FHA Home Loans are guaranteed by the government, every lender can have higher FHA Credit Score Requirements called lender overlays
  • Just because one lender turns down  a borrowers does not mean that borrower cannot qualify with a different mortgage lender
  • The first organization most home buyers turn to when applying for a home loan is their local bank
  • However, most banks require a 640 credit score even though FHA Credit Score Requirements are 580
  • This is due to lender overlays

What Are Lender Overlays

There are two sets of FHA Guidelines:

  1. Agency Guidelines mandated by the U.S. Department of Housing and Urban Development
  2. Lender Overlays

All lenders needs to meet Agency Guidelines mandated by HUD. However, every lender has a right to have its own lender overlays that are above and beyond those of the minimum agency guidelines. For example, HUD requires a 580 credit score for home buyers to qualify for FHA Loans with 3.5% down payment. However, most banks will not accept any borrowers without a 640 credit score. This higher lending guideline imposed by lenders are called lender overlays. Gustan Cho Associates Mortgage Group is one of the very few national lenders with no overlays on government and conventional loans. Over 75% of our borrowers are folks who could not qualify at other lenders due to their strict overlays on top of agency guidelines.

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