Reader question: “I was recently turned down for a mortgage. I was told the reason was that my credit score was too low for the FHA loan program, which is what I was applying for. How high does a score have to be for this kind of loan, and what can I do to improve mine to the point that I can qualify?”
When your credit score is too low for an FHA mortgage loan — or any type of home loan for that matter — you should receive a disclosure from the lender stating this reason. These “adverse action notices,” as they are known, are required by law these days. They usually include a copy of your credit score as well. (It sounds like you know this already. I’m sharing it for the benefit of other readers.)
So let’s move on to the heart of your question. What can you do if your credit score is too low for a mortgage loan, FHA or otherwise? Here are some things you should know…
What to Do If Your Credit Score Is Too Low for a Mortgage
The first thing you need to do is find out where you stand exactly. Start by getting a copy of your score from all three of the credit-reporting bureaus that produce them. This would be Experian, TransUnion and Equifax.
The score you get from the bureaus might be slightly different from the one mortgage lenders obtain from these bureaus. But it will be close enough for research purposes. The goal here is to find out where you stand, and how much you need to improve your score to put it within approval range for a mortgage loan.
Which begs the question: What credit score do you need to get an FHA loan these days?
The Department of Housing and Urban Development (HUD) manages the FHA loan program. According to the official HUD guidelines, borrowers need a minimum “decision credit score” of 500 or higher to qualify for the program. But that’s just for basic eligibility. To qualify for the 3.5% down payment option (which is the main reason most people use this program in the first place), borrowers need a score of 580 or higher. Learn more
But mortgage lenders often impose their own guidelines as well, and they are typically stricter than HUD. Most of the lenders I’ve spoken to (by email, and also through informal surveys and questionnaires) have said they want to see a score of 620 or higher for FHA-insured mortgage loans. Some will go as low as 600, or maybe even lower.
Some lenders appear willing to “match” the HUD requirement, by allowing credit scores in the 500 range — but they are an exception to the general trend. Generally speaking, the bar seems to be set at or around 620 on the FICO scoring scale. (This number is not set in stone.)
If your credit score is too low for an FHA mortgage loan, there are certain proactive steps you can take to improve it. You might feel powerless right now. But you are not powerless. It’s entirely possible to improve your credit score over time, as long as you pay all of your bills on time going forward. So let’s talk more about that…
Paying Your Bills on Time
I’ve just told you the most important step to take in your quest for better credit. Make sure you pay all of your debts on time, and in full, going forward. I’m primarily talking about the kinds of accounts that show up on your credit report. This includes car payments, credit cards, personal loans, an existing mortgage (if applicable), etc.
There’s a good chance this is what hurt your score in the first place — falling behind on your bill payments. Even a single late payment or delinquency can cause your credit score to drop too low for mortgage loan approval. It matters that much.
In credit-reporting jargon, this is referred to as your “payment history.” Your payment history accounts for 35% of your overall score — more than any other single factor. So make sure you pay all of your debts on time going forward. Nothing else will matter if you ignore this particular advice. It’s mission critical.
Reducing Your Credit ‘Utilization Ratio’
It’s also wise to limit your use of credit going forward. Keep those cards locked up somewhere. Resist the urge to use them, unless it’s absolutely necessary. Avoid taking out any other loans or credit lines.
In reporting jargon, this is referred to as your “amounts owed.” It’s also known as the “credit utilization ratio.” In short, if you are using a high percentage of your available credit limit, it could have a damaging effect on your score. “Maxing out” your cards can be particularly harmful. This could be another reason why your credit score is too low for a mortgage loan at present. Investigate. Find out where you stand. Measure your utilization ratio.
So how do you improve this aspect of your financial picture? As I mentioned above, you can start by limiting your credit usage. Piling additional debt onto your existing debt will not help your cause. It will likely put that mortgage loan even further out of reach. It takes discipline. You may have to curtail your spending and forego a few luxuries. But it can be done.
Additionally, if your credit card balances are currently very high in relation to the limits, you might want to consider paying them down to achieve a more favorable ratio.
Of course, if cash is tight at the moment, you probably don’t have any “extra” money to put toward your credit card payments. But if you do have some extra funds each month, you might consider paying more than the “minimum amount due,” which is typically the only way to reduce a credit card balance. (The minimum amount due is designed to keep you paying interest for a long, long time — in case you haven’t noticed). It’s something to consider, at the very least.
If you pay all of your bills on time, and maintain low credit card balances in relation to your limits, there’s a good chance your score will rise in time. How long it might take is not something I can say. Nobody can predict that, because there are too many variables at work. The point is that you have to start somewhere — and the sooner you start, the faster you’ll reach your goal.
Disclaimer: This article explains some of the steps you can take when your credit score is too low for an FHA loan or a conventional mortgage loan. Please note that these are not my personal recommendations. I am not a financial advisor or a credit-scoring expert. These recommendations are widely available on the internet, and many of them come from myFICO.com (the company that actually designed the FICO credit-scoring system). As such, I make no claims or guarantees about the efficacy of these strategies. I have merely shared them with you for educational purposes, and to give you some material for additional research. Use them at your own risk.