FHA mortgages have lower credit score standards
An FHA mortgage is insured by the federal government. To be eligible for an FHA mortgage, borrowers must have at least two established credit lines, a debt-to-income ratio (DTI) of 31% or less excluding the expected mortgage payment, and no delinquent federal debts.
As long as those requirements are met, an FHA borrower with a rather low credit score for a home loan can still qualify. FHA loans with a rock-bottom 3.5% down payment are available with FICO® Scores as low as 580. And if a borrower can come up with at least 10% down, the FICO® Score requirement drops to 500.
It's important to mention that lenders can set stricter standards if they want, just as with conventional loans. For example, a mortgage lender that offers the low-down-payment FHA loan could potentially set its own minimum FICO® Score requirement at 600, not 580.
The caveat to FHA loans is that the mortgage insurance is expensive. FHA loans have ongoing annual mortgage insurance premiums of between 0.45% to 1.05% of the loan balance. That's competitive with the private mortgage insurance (PMI) paid by conventional borrowers with less than 20% down. However, FHA loans also have an upfront mortgage insurance premium of 1.75% of the loan amount. With a $250,000 loan, this translates to $4,375 -- not a small amount of money. See our list of the best FHA lenders to research more.
Other types of mortgages
Several of the best mortgage lenders for first-time home buyers offer lower down payments and more flexible credit requirements. In addition to conventional and FHA mortgages, the credit score for a mortgage can be lower with the following types of mortgage loans:
VA loans: VA loans are available to certain current and former members of the U.S. Armed Forces. There is no formal minimum credit score for a home loan, but most lenders want to see a FICO® Score of at least 620 to originate a VA loan.
USDA loans: A USDA loan is a type of financing available for borrowers with low-to-moderate income buying homes in certain rural areas. While there isn't a set-in-stone credit requirement, most USDA lenders want to see a score of at least 640.
It's not just about your credit score for a mortgage
Your credit score for a home loan is certainly an important factor, but it is just one piece of the puzzle. In addition to your FICO® Score, your mortgage lender will consider:
- Your down payment: The minimum down payment for a conventional loan is 3% for first-time buyers. But higher down payments can increase your approval chances and also lower your interest rate. Plus, if your down payment is less than 20%, you'll likely have to pay for PMI.
- Your income: Lenders want to know that you earn enough money to justify the loan. Generally speaking, lenders want to see that your new housing payment will make up less than 28% of your pre-tax income and that your total debts (including your mortgage payment) will be less than 45% of your income.
- Your assets: If you have substantial money in savings, lots of investments, or other assets, it can help bolster your mortgage application. In fact, lenders generally require that you have a certain number of mortgage payments (say, six months) in reserve.
- Your employment history: Not only does your lender want to see enough income to justify the loan, but it also wants to know that your income is likely to continue for the foreseeable future. As a general rule, lenders want to see at least two years of steady employment in the same industry, with no significant gaps.
If your credit score is close to the minimum, you're likely to need very strong qualifications in the other areas.
The credit scores and other qualifications of actual mortgage borrowers
Most mortgage borrowers have significantly higher credit scores than their particular loan program requires. As of September 2020, the average home buyer who obtained a conventional purchase mortgage had a FICO® Score of 759, according to Ellie Mae -- a score largely considered to be great credit.
What's more, the average buyer put 19% down and had an overall debt-to-income ratio of 35%. This is more money down than a conventional loan requires, and is also a significantly lower DTI.
Even for an FHA loan, the average credit score for a mortgage was a 684 FICO® Score. That's generally considered to be good credit, and significantly above the minimum requirement. The average FHA borrower only put 4% down and had a relatively high 43% DTI. This makes sense, as FHA loans are typically used by borrowers with little cash to put down.
Here's why you should aim for a higher credit score for a home loan
Just because you can qualify for a conventional mortgage with a 620 FICO® Score, or an FHA loan with a FICO® Score in the 500s, doesn't mean it's the best idea. FHA loans are expensive in general, and conventional lenders base your mortgage's interest rate on your FICO® Score, among other factors. With a low FICO® Score, you could end up paying tens of thousands of dollars in additional interest on your loan, relative to a top-tier borrower.
Let's put some numbers behind this. Zillow's latest data puts the median home value in the United States at about $343,000. A 20% down payment (the average for a conventional loan), would imply a mortgage amount of $274,400. Here's what type of mortgage payment this could translate to on a 30-year fixed-rate conventional mortgage. We've based our calculations on the latest average rates by credit score for a home loan:
