I am often asked if there is a minimum credit score required for government loans such as FHA financing so here is the answer.

QUESTION:  Is there a minimum credit score needed to obtain an FHA loan?

ANSWER:  Yes, FHA does have minimum credit scores HOWEVER, what you need to be aware of is that virtually every bank has set much higher minimum credit score requirements than those required by FHA!

Over the past year or so, I have watched banks adjust their own internal lending guidelines with regards to credit scores.  There was a time when all you needed was a minimum credit score of 550 but as loan defaults continue, most banks have raised the bar and have set ever increasing minimum credit score requirements. 

Right now most banks want a minimum score of 620 and there are some banks who want even higher scores.

IS THIS LEGAL?

The answer is yes.  As long as it is not against the law or discriminatory then a lender can set their own guidelines.

WHY IS THIS HAPPENING?

There are many reasons this is happening but in short, it is the banks attempt to reduce risk.  Here are the core reasons and risks:

1. Currently, government backed mortgages (not just FHA) account for just under 90% of all mortgages written in the US.  This is a huge number and in one way it is a positive factor.  Imagine how even more difficult it would be for a borrower to find a mortgage if government backed mortgages were not available?  These are loans that are often written with less than the customary 20% down and it would be a far worse trying to qualify for a loan if these mortgages were not available.
2. FHA ranks the banks by default rates.  A high default rate can cause a bank to lose their FHA status and not be able to write those types of loans.  Assume for a moment that one third of all loans written are FHA.  It’s a good assumption that any individual bank is writing roughly the same percentage.  Therefore, if a banks loss ratio is high and they could no longer write those types of mortgages, it would be a disaster for the bank as roughly one third of their business would be gone.
3. Banks also make money service the account when a loan is sold.  The borrower sends their payment into the bank who keeps a small amount as their profit for servicing the loan and maintaining the escrow accounts.  The remainder is forwarded to the investor who owns the loan.  When a loan goes into default, there is still a cost of doing business to try to bring the account current as well as maintaining the escrow accounts etc.  This cost is not reimbursed by FHA when the borrower is in default or the loan has gone into foreclosure.
4. If a borrower defaults in the first year, the bank often has to buy back the loan so the banks are seeking a more qualified buyer than they were just a few months ago.

RECAP

As defaults increase, the banks have moved into the protection mode and are increasingly making guidelines and policy more stringent than what FHA and other government backed mortgages require.  The thought is that borrowers with higher credit scores are less likely to default.  That will remain to be seen as unemployment increases and other pressures on consumers build. 

The negative to all of this is that a buyer who was pre-qualified yesterday, my be bumped out of obtaining a mortgage by the new standards that banks are imposing.  If you were pre-qualified over 30 days ago, you may want to check and see if you still qualify and meet any new minimum credit score requirements that many banks have recently imposed.

The good news is that there is still mortgage money available with little or nothing down and at historically low rates. 

Please call if you have questions.  It is my pleasure to provide you with all the information you need to make an informed decision.