Most people assume that any loan program requires great credit, including the 203K Mortgage Loan program. The good news is that no program requires “great” credit. Every program looks at the overall picture of your loan profile to determine your risk level. Most programs do have minimum credit score requirements, including the 203K program, which prefers credit scores over 580, but as you can guess, a score of 580 is far from great, which means that this FHA-backed program does not require you to have great or even good credit, as long as you have other compensating factors. If you do have a credit score as low as 580, it is preferable that the derogatory credit is at least 12 months behind you, but certain lenders will make exceptions if you can show that you have recovered from the period of derogatory credit.
Housing History is Important
One of the largest factors the FHA looks at is your housing history, whether mortgage or rental history. The cleaner your housing history, the more likely it is that you will get approved for the 203K mortgage loan. So what does a clean housing history look like? Typically, no more than one late housing payment in the last 12 months is allowed. If there is more than one late payment, you need to have good reasons for those late payments. The FHA rules do allow for up to three late housing payments in the last twelve months, but not too many lenders will allow that many late payments without adequate reasons for the late payments. Your housing payments can be verified by your credit report if you have a mortgage right now and wish to refinance into a 203K loan or it can be verified by your landlord and canceled checks if you currently rent and wish to purchase a home that needs to be fixed up.
Other Trade lines and their Importance
Your other trade lines should be in good standing as well, even though they do not hold the same level of importance as your housing payments. Any late payments can hurt your ability to get the 203K loan, but if you can show that your late payments were a one-time occurrence and that you have since brought your payments current and have paid them on time. Any trade line that reports on your credit report plays a role in your ability to get the 203K mortgage loan, so do not take any chances with any of your accounts. The more liabilities you can pay on time, the better off your chances of getting approved will be. If your credit history is more than a little blemished, it is a good idea to fix it up before applying for the FHA loan just to increase your chances of getting approved with lower interest rates.
So what happens if you do have “bad” credit? Are you ineligible for the 203K loan? The good news is that you can probably still be a good candidate for the loan, but you have to have compensating factors. This could mean many different things, depending on the circumstances surrounding your application. A few examples of compensating factors include:
- Low debt ratio – The lower your debt ratio, the lower the risk you pose to the lender. The FHA guidelines for the 203K loan are 29/41, but that does not mean that you should have ratios that high. The lower your ratios, the better you can afford a new loan.
- Plenty of reserves – Money in your bank speaks volumes to lenders. The more money you have on hand, the better chances you have of getting a 203K loan. Reserves are money you have set aside in a liquid bank account that can be used to pay your mortgage if your standard income becomes unavailable. Lenders measure your reserves based on the number of months the money you have set aside will cover – the more months you can cover, the better your chances of getting approved.
- Good housing history – You can have a low credit score and have a good housing history if you have made your revolving or installment payments late. The FHA puts the most emphasis on the housing payments, which can be a compensating factor if your credit score is low. As you work to increase your credit score, having on-time housing payments can work in your favor.
- Stable income – The general rule is to hold the same employment for at least two years in order to be eligible for an FHA loan, but there are ways around that requirement. However, the longer you have the same employment and stable income, the less risk you pose to the lender.
Apply with Different FHA 203(K) Lenders
The best thing to do when you do not have great credit and wish to use a 203K mortgage loan is to apply with different lenders. Lenders can add their own requirements on top of the general FHA rules, which state that you must have:
- A credit score higher than 580
- Debt ratios around 29/41
- No more than one late payment in the last 1 months
- Stable employment/income that can be verified
- 5% LTV or lower
If a lender tightens the requirements in order to qualify for the 203K mortgage loan, it might disqualify you if you do not have great credit or have enough compensating factors. But because every lender has different requirements, you might find a lender that is better able to provide you with a loan approval. Every lender has their own level of risk that they can accept, making different borrowers eligible or different programs.
The 203K mortgage loan is a great way to purchase a home and have the money you need to fix it up. If you do not have great credit, do not assume you are not eligible for the loan program. Shop around with various lenders to see who will accept your level of risk and provide you with the most favorable terms for your loan!