Bad credit limits your options for mortgage financing because lenders believe you are more likely to default than a borrower with strong credit. The Federal Housing Administration offers some of the most forgiving credit guidelines in the mortgage marketplace. Low credit scores, recent collections and previous foreclosure and bankruptcy are common missteps that lead to bad credit. The FHA insures loans made by approved lenders, giving them credit guidelines to follow when considering applicants. Lenders sometimes impose more stringent guidelines, making it harder for FHA applicants to qualify, but borrowers can demonstrate other financial strengths to get a loan.
Check your credit score with a credit-reporting company that uses the FICO scoring system. FICO scores, created by the Fair Isaac Corporations, run between 300 and 850. Mortgage lenders rely on tri-merged credit reports, which include FICO scores generated by the three major consumer credit bureaus: TransUnion, Equifax and Experian. FHA lenders use the middle of the three scores, rather than the highest or lowest scores. When more than one applicant is involved, it uses the middle score of the borrower with the lowest credit score.
Raise you credit score in a short amount of time to meet the lender's minimum score requirement for an FHA loan. Many lenders require a minimum score of 640, rather than the FHA's minimum requirement of 500. Reducing the total balance owed on credit cards to 30 percent or less boosts your scores as soon as the creditor reports the new balance. You can also increase your score quickly by getting your creditor to increase your credit limit, as long as it does not entail a credit check, which diminishes your score.
Gather a sufficient down payment based on your FICO score. The FHA requires at least 3.5 percent of the sale price as down payment when your score is 580 or more. As of April 1, 2013 it requires 5 percent down for loan amounts exceeding $625,000, regardless of credit scores. The FHA requires a minimum down payment of 10 percent from borrowers with scores between 500 and 579. Lenders may require that your down payment comes from your own funds, as opposed to gifted funds from a family member, nonprofit or government agency.
Save money and increase your income, which the lender considers compensating factors for approving your loan. The more reserves you have in the bank, as demonstrated through account statements, the better your chances of getting a loan. Several months worth of housing payments in reserve show the lender that you make enough money to save and have a conservative attitude toward spending, which can make up for past credit missteps. You can increase your income through seasonal work or getting a second job. Commissions, bonuses, overtime and tips also boost your income, as long as you report the additional income on your taxes and your employer can verify the amount and frequency.
Wait the minimum required time, also known as a seasoning period, if your bad credit involves a past foreclosure or bankruptcy. The FHA requires that you wait at least three years before applying for a loan after a foreclosure or deed-in-lieu of foreclosure, in which you sign ownership of the home back to the lender. It requires at least a two years' waiting period after liquidating your debts in a Chapter 7 bankruptcy and one year after a Chapter 13 bankruptcy, which involves a repayment plan.
- Lenders often require a minimum score of 640 to participate in FHA's programs, despite your credit score.
- Before applying for an FHA loan, find an FHA-approved lender using the Department of Housing and Urban Development's online look-up tool. FHA-approved lenders are knowledgeable about the agency's credit guidelines and are approved to do business with HUD -- from taking FHA loan applications to servicing the loans once funded. Credit unions, mortgage brokers, banks, savings and loans and mortgage companies may offer FHA loans.
- HUD: Handbook 4155.1
- Federal Register: Federal Housing Administration (FHA) Risk Management Initiatives: Changes to Maximum Loan-to-Value Financing Solicitation of Comment
- Los Angeles Times: FHA Rescinds Tough New Credit Restrictions on Loan Applicants
- Bankrate.com: With My Credit Score, What Interest Rates?
- Fox Business News: How Your FICO Credit Score is Calculated: How Much You Owe
- HUD: FHA Lender List
- David Sacks/Lifesize/Getty Images