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FHA loans are popular among first-time home buyers, as well as those with credit problems and/or a lack of down-payment funds. Generally speaking, it’s easier to qualify for an FHA loan than a conventional mortgage. But they might be harder to obtain in 2013. A new rule to take effect in 2013 puts extra emphasis on the borrower’s credit score.
We’ll get to the rule changes in a moment. But first, a bit of background. Here’s a quick overview of FHA loans, credit scores, and how they relate to each other during the mortgage application process.
FHA loans — The Department of Housing and Urban Development (HUD) manages the FHA program. Through this program, borrowers can obtain a mortgage loan that is insured by the federal government. The actual financing is provided by a lender in the private sector, as with any other type of mortgage. It is the government backing that makes FHA loans unique. The insurance protects the lender from financial losses resulting from borrower default, or failure to pay. These loans are popular among home buyers due to their small down-payment requirements (3.5 percent) and flexible qualification standards.
Credit scores — This three-digit number is based on information found within a consumer’s credit report. The reports themselves compile information pertaining to the repayment of loans and credit accounts. This data is then put through a computerized scoring system to produce a numerical score. The FICO credit score is the one most commonly used by mortgage lenders. The FICO scoring range goes from 300 to 850. A higher score will increase the borrower’s chance of getting approved for the loan; a lower score hurts the chance of approval.
How mortgage lenders use them — Credit scores are essentially a measurement of risk. Consumers who pay all of their debts on time, and in full, typically have higher scores as a result of those responsible actions. On the other hand, people who routinely neglect their bills typically have lower scores. Bankruptcies, foreclosures and debt collections can also severely lower a person’s credit score.
When you apply for an FHA loan, the lender will check your credit score to see how you’ve borrowed and repaid money in the past. They will base their lending decision partly on this three-digit number.
HUD Issues New Credit-Score Rules for 2013
On December 18, 2012, Carol Galante, the acting commissioner of the Federal Housing Administration (FHA), sent a letter to Sen. Bob Corker of Tennessee. Mr. Corker is one of many in congress who are pressing for change at the FHA. Here is an excerpt from that letter:
“FHA … will require borrowers with scores below 620 to have a maximum debt-to-income ratio no greater than 43 percent in order for their loan applications to be approved through FHA’s TOTAL Scorecard … If a borrower’s DTI exceeds 43 percent, lenders will be required to manually underwrite the loan.”
What this means is that any FHA borrower with a credit score below 620 will receive extra scrutiny from the mortgage lender. This scrutiny will focus on the borrower’s debt-to-income ratio, or DTI.
See also: Credit score needed to buy a house
As its name implies, the debt-to-income ratio is a numerical comparison between (A) how much money a person earns, and (B) how much they spend to cover their various debts. Calculations are made at the monthly level, using gross monthly income and total debt expenditures. The 43 percent requirement is for the total or “back-end” ratio, which means it includes the mortgage loan and all other debts the borrower has — credit cards, car loan, student loan, etc.
Summary: In 2013, there will be some new credit-score requirements for FHA loans. A borrower with a score of 620 or higher, manageable debt levels, and steady employment should have no trouble qualifying for the program. A borrower with a score below 620 will face additional scrutiny in the area of debt-to-income ratios. If the latter borrower has a DTI ratio higher than 43 percent, he or she might not qualify for an FHA loan.
See also: An overview of FHA guidelines for 2013
Disclaimers: This article covers qualifying criteria for the FHA loan program, and credit-score requirements in particular. This information has been provided for educational purposes only. We are not mortgage lenders. Only a mortgage lender can tell you whether or not you meet their guidelines. Furthermore, we encourage readers to continue their research well beyond this website. The credit-score rules mentioned in this article were based on statements made by officials at the Federal Housing Administration.