Credit Score Below 500? No FHA Home Loan
The door that was once wide open to homeownership closed a bit recently when a key government agency announced a proposal to no longer allow mortgages for borrowers with credit scores below 500.
The Department of Housing and Urban Development (HUD) said that it intends to require borrowers to have scores of at least 500 to qualify for FHA-insured loans. The agency has not required a minimum score before.
The practical impact of this move will be extremely limited; during the second quarter of 2010, no FHA-insured loans were issued to borrowers with sub-500 scores. And, in fact, less than 1% of borrowers were below 580; most loans went to borrowers with scores above 620.
HUD has been expressing increasing concern over default risk in the wake of the housing bust. The percentage of delinquent FHA loans has trended up, as have rates for virtually all mortgage loans.
The FHA had earlier proposed steps to reduce delinquencies and so therefore cut risks. One was to raise the minimum downpayment to 10% for borrowers with credit scores below 580.
Another was to reduce allowable seller concessions to no more than 3% of the sale price. That would force buyers to make more of a financial commitment to their home. It is generally believed that given more "skin in the game," homeowners are less likely to default.
These policies are all still in the proposal stage. Before going into effect, the department is soliciting public comment on the matters for 30 days. Then, it will evaluate the comments before implementing any changes.
FHA Mortgage Changes Now in Effect
If you are looking to get an FHA home loan there are some changes you need to know about that just went into effect on April 5th. The changes are not all bad, fortunately, but the expensive one for borrowers is the cost of upfront mortgage insurance premium.
The upfront mortgage insurance premium has increased from 1.75% to 2.75% at the closing table. That is some serious money when you are buying a home. However, the reality is that borrowers are going to be on the lower end of the credit scale so this makes sense for the government program to add in the extra protection.
FHA has turned into the lender of last resort as the credit market has tightened for many borrowers. But if your credit is dinged and you can make a significant down payment the program is not too bad.
Under the FHA Reform Act of 2010, anyone with a credit score between 500 and 579, and at least a 10% down payment, can probably obtain FHA financing. Additionally, purchasers with 5% or 10% to put down on a home could see lower mortgage insurance premiums. Other changes include decreasing the amount of seller contributions allowed from the current 6% down to 3%, and increasing the down payment amount to a straight 3.5% of the purchase price. When compared to conventional loans, these changes make FHA loans a more expensive loan option. Even so, many first time home buyers have trouble obtaining the 5% down payment required on conventional loans. FHA calculations estimated a reduction of 40% in loan originations it they were to implement a 5% down payment option.
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