How to Apply for FHA Loans with Bad Credit

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Contributor, Benzinga
August 14, 2023

Buying a home can be expensive and stressful, especially for those with poor credit or spotty financial history. FHA loans provide a way for such individuals to obtain home financing. Insured by the Federal Housing Administration, FHA loans are accessible to those with lower incomes, lower credit scores and prior financial missteps.

The Federal Housing Administration offers a variety of loan programs to assist homebuyers in purchasing a home. These loan programs have lenient credit requirements, making them attractive options for people with lower credit scores. In this guide, we'll cover FHA loans for people with bad credit and how to get a home loan.

5 Best FHA Loans for Bad Credit

If you have bad credit and are in need of an FHA loan, look no further. Below are 5 top options for the best FHA loans for bad credit, where you may have the opportunity to get past an iffy credit report.

While an FHA loan may be the right solution for borrowers with poor credit, not all lenders are created equal. Mortgage backers vary in minimum accepted credit scores, rates charged and closing time. You can begin exploring some of the best FHA loan providers for those with bad credit using Benzinga’s list below. 

1. Best for a Variety of Options: New American Funding

New American Funding is an excellent lender for bad credit borrowers to turn to for FHA loans. Requiring a downpayment of just 3.5%, New American Funding is a reliable lender for a range of buyer types. In some cases, New American Funding allows nontraditional credit proof, ideal for those with no credit score established, but generally, New American Funding believes that a 640 credit score is sufficient.

New American Funding sets a 1% origination fee for all of its FHA loans, with 30-year and 15-year options available. New American Funding excels in efficiency, offering a guarantee of closing in 14 days for some borrowers. Typically, for other borrowers, the mortgage is closed in between 30 and 45 days. 

Pros

  • Reasonable origination fees help you save money
  • You can choose from a range of loan terms
  • Some loans can close in 14 days

Cons

  • Minimum credit scores can shift at any time depending on the movements of the market, etc, especially because NAF asks for a much higher “sufficient” credit score than the competition

2. Best for Online Mortgages: Rocket Mortgage LLC

Rocket Mortgage, recognized for its simple online applications and helpful customer service, allows borrowers to obtain an FHA loan with an average credit score of only 620. You will also need a minimum downpayment of 3.5% of the home purchase price for FHA loans. 

Rocket Mortgage’s FHA loan rates are competitive with others on the market but tend to be a bit higher than some competitors. For homebuyers looking for an especially straightforward application process, this small increased fee might be worth the charge. Loan origination fees on FHA loan options range from 0.05% to 1%. Generally, borrowers can expect the closing time to take between 30 and 45 days when they get their loan through Rocket Mortgage. Besides offering online application options, the lender also created a mobile app that allows borrowers to conveniently manage their loans. 

Pros

  • Low down payments help you prepare for these loans
  • You can complete the process all online and save time and headaches
  • Lower origination fees are a welcome sight for borrowers

Cons

  • The average credit score that the lender requires is higher than you would expect for an FHA loan

3. Best for Discounted Rates: PNC Bank

PNC Bank is another reputable lender for those seeking an FHA mortgage for bad credit. Compared to some other lenders, the minimum credit score required by PNC is somewhat high; you’ll need a score of at least 620 points to qualify. 

However, PNC deserves a spot on this list because of the grants it offers toward closing costs. Depending on your qualifications, you could qualify for a homebuyer’s grant of up to $5,000, which can go toward closing costs, your prepaid escrow costs or, in some cases, your down payment. As this offer is for a grant (not another loan) you also won’t need to worry about paying back the money later. 

The total closing fees charged on PNC’s FHA loans range from 3% to 5% of the loan amount. Interest rates may vary based on the loan amount, type, region and date. PNC does not provide information regarding the average closing time, but as a large lender, it can be expected to be somewhere around the industry average of 47 days. 

Pros

  • PNC is a solid bank with strong backing and the customer support you’re looking for
  • PNC has a quality website that’s easy to use once you obtain your loan

Cons

  • Not everyone will qualify for a grant or a loan with a lower credit score
  • Closing sits at the industry average, which could be slower than most

4. Best for Closing Cost Credits: Guild Mortgage Co.

Borrowers with credit scores as low as 540 may qualify for Guild Mortgage's FHA loan. When a borrower's credit score falls under 580, a minimum down payment of 10% is required to qualify. Borrowers with credit scores above this threshold will be able to make lower down payments, at a minimum of 3.5%. 

Guild Mortgage incentivizes borrowers with the Homebuyer Express program, which offers a 17-day closing guarantee. If this deadline is not met because of the lender, qualifying borrowers will receive a $500 credit toward closing costs. Besides the Homebuyer Express details, Guild does not provide information regarding average closing timeframes. Guild also does not list details regarding rates online, so potential buyers must speak with a loan adviser for this information. 

While no specific amount is provided regarding origination fees, Guild Mortgage suggests that closing costs range from 2% to 5% of the home value. On the lender's website, there are several types of mortgage calculators available, so prospective borrowers may be able to estimate monthly payments before applying for their loan. 

Pros

  • You can qualify with a much lower credit score than the competition requires
  • Closing guarantees can help you get into your home faster

Cons

  • Closing costs could be fairly high depending on your loan and contract
  • Not everyone qualifies for closing cost credits

5. Best for Quick Closings: PennyMac Financial Services Inc.

  • securely through PennyMac's website
    securely through PennyMac's website
    Best For:
    Quick Closings
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PennyMac is a dependable lender for FHA loans for bad-credit borrowers.  For an optimal down payment of 3.5%, a credit score of 620 is required; however, the lender accepts credit scores as low as 500 and a traditional FHA loan generally requires a minimum credit score of 580. To obtain an FHA loan, PennyMac requires borrowers to obtain a home appraisal by an FHA-approved appraiser, maintain a 50% maximum debt-to-income ratio and for the home to be their primary residence. 

The loan provider is transparent regarding rates, although borrowers must contact a loan officer for rate details for certain loan types, such as the FHA loan. PennyMac stands out in terms of fees because the lender waives its $1,000 origination fee for those purchasing a home using an FHA loan. The closing process takes from 30 to 45 days. 

Pros

  • Origination fee waivers make it much easier for many borrowers to close
  • You can get into a mortgage with a higher-than-expected DTI ratio

Cons

  • The credit score requirement is a little higher than you might expect

What is an FHA Loan?

An FHA loan is a special type of government-backed mortgage option for borrowers who have lower incomes or do not qualify for conventional mortgage loans because of their credit history. FHA loans are backed by the federal government, which means they present less of a risk to lenders — if you don’t repay your loan, the bank won’t be responsible.

This means that banks can afford to lower the qualification criteria when deciding who should be approved for a home loan. You can come in with a lower FICO score in some cases, and you can even merge a home equity loan with an FHA loan for the purposes of refinancing.

FHA loans come with rules that dictate what type of home you can buy. To qualify for an FHA loan, the home you’re buying must:

  • Be in livable condition, as defined by an FHA home appraiser
  • Be your primary residence for at least one year after closing
  • Have a value within the FHA’s property loan limits set for your area

You also must move into the property you’re buying within 60 days of closing and provide proof of ongoing employment. Don’t forget that all these requirements fall outside of your creditworthiness.

These are requirements set in place by the federal government for properties that qualify for purchase with an FHA loan. Individual lenders may have other qualification criteria you’ll need to meet, and requirements will vary from lender to lender. You don’t make a security deposit, you may a down payment. There’s no credit limit because the loan has a singular value, and your mortgage payment stays consistent (unless you pay your taxes and insurance through the lender, meaning prices could vary.)

How to Prepare for an FHA Loan

While FHA loans were designed for buyers who may not meet the financial qualifications required on a conventional loan, there are still a few qualifications you’ll need to meet to be approved. Use these steps to prepare for your FHA loan application.

1. Check Your Credit Score

Your FICO credit score is a three-digit number that represents the likelihood that you will pay back any money you borrow in a mortgage loan. To qualify for an FHA loan, you’ll need a credit score of at least 500 points. Some lenders will not accept any FHA loan applications for borrowers with credit scores below 580 points, so this is a good threshold to aim for when applying for an FHA loan. However, FHA loan requirements shift from one lender to the other.

Check your credit score and make sure you’ve got a score of at least 580. If your score is lower than that, take some active steps to build credit before applying for your loan. You can review your credit history for free at annualcreditreport.com.

2. Prepare to Show Your Income History

One of the most essential requirements for homebuyers is that they must provide proof of steady income and employment history. On average, lenders will want to see a minimum of two years of employment history. If you're self-employed, be prepared to have to show a long history of steady income. 

3. Pay Down Your Debt

FHA lenders take a figure called your debt-to-income (DTI) ratio into account when qualifying you for a loan. Your DTI ratio represents the percentage of your monthly income that goes toward outstanding debts in addition to your home loan if you already have one. Buyers with low DTI ratios have an easier time qualifying for loans because they are less likely to default on their mortgages.

To calculate your debt-to-income ratio, divide the recurring minimum monthly payments you owe by your total pre-tax household income. For example, imagine you earn $3,000 per month. You make a payment of $100 toward your credit card bill, $500 toward a car note and $200 toward your student loans every month. In this instance, your DTI ratio would be about 27% because about 27% of your gross monthly income ($800) goes toward recurring debt payments every month.

To qualify for an FHA loan, you must have a DTI ratio of 43% or less. Calculate your DTI ratio and make sure that it falls within this range. If you have a higher DTI ratio than what you can use to get a loan, you might want to focus on making additional payments on your other outstanding balances before you think about buying a home.

At the same time, paying down debt creates an even better payment history. Plus, you’ll be able to keep more money in your checking account for a down payment.

4. Save a Down Payment

You must have a down payment of at least 3.5% of the purchase price of your home to qualify for an FHA loan as a home buyer looking for their primary residence. This minimum only applies if you have a credit score of at least 580. If your score is lower than 580, you’ll need to bring a 10% down payment to the closing table to qualify.

Refinancing FHA Loans With Bad Credit

If you have an FHA loan, it is possible to refinance to a lower rate or a shorter term. Not only is it possible to refinance an FHA loan, but it could also be even easier than refinancing a conventional loan if you qualify for an FHA Streamline refinance.

An FHA Streamline refinance allows borrowers who qualify to refinance their loan on a faster timeline and without providing as much documentation. Part of the FHA Streamline refinance includes skipping the credit check portion of your loan application, which can be hugely beneficial if your credit has taken a dive since you moved into your home. So, if you skip the credit check and can reduce your debt payments, you could even tack on something like another home equity loan or construction loan (requirements will vary).

To qualify for an FHA Streamline, you must already have an FHA loan, and you must be refinancing to a loan with an immediate net benefit over your current loan. Some examples include refinancing to a lower interest rate or taking a loan with a longer term to lower the amount of money you pay each month. You must also meet the following qualifications:

  • Have lived in your current home for at least six months
  • Have made at least six on-time payments on your FHA loan
  • At least 210 days must have passed from the closing date of the mortgage you’d like to refinance

You also cannot have more than one late payment on your loan in the last 12 months, and you cannot have any missed payments on your loan in the last six months to be approved for an FHA Streamline refinance.

Consider FHA Loans for Flexible Home Financing Options

In conclusion, FHA loans can be an excellent option for first-time homebuyers or those with less-than-perfect credit. They offer lower down payments, more flexible credit requirements, and often have lower interest rates compared to conventional loans.

However, FHA loans do come with some additional costs, such as mortgage insurance premiums. It's important to carefully consider your options and work with a trusted lender to determine if an FHA loan is right for you. You also need to watch your credit utilization ratio, check on prevailing mortgage rates, monitor your FICO credit score and seek out a home mortgage that’s right for your family. With the right preparation and guidance, FHA loans can be a valuable tool to help you achieve your dream of homeownership.

One more thing, if you’re looking at an investment property, you generally need to put 20% down on a conventional loan.

Frequently Asked Questions

Q

Can I still qualify for an FHA loan with bad credit?

A

Yes, FHA loans are designed for people with lower credit scores. The minimum credit score requirement varies by lender and can range from 500 to 580. It is important to shop around to find a lender that is willing to work with your credit history.

Q

What documents do I need to apply for an FHA loan with bad credit?

A

You will need to provide proof of income, employment history, tax returns and bank statements. If you have a lower credit score, you may also be asked to provide additional documentation such as a letter of explanation for any negative marks on your credit report.

Q

What are the advantages of obtaining an FHA loan with bad credit?

A

One of the main advantages of an FHA loan is that it requires a lower down payment than traditional loans — as low as 3.5%. Additionally, FHA loans have more lenient credit score requirements and may be able to offer a lower interest rate than other types of loans. You may have to pay mortgage insurance for the life of the loan, which can increase your overall monthly payment.

Get Ready for Take Off

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You can work at your own pace and someone is always there to answer your questions — 24 hours a day, 7 days a week. Want a fast, convenient way to get a mortgage? Give Rocket Mortgage® a try.