Reader question: “We are planning to buy a home later this year and plan to use an FHA loan. We currently have quite a bit of credit card debt. Is it possible to qualify for an FHA loan with credit card debt? Are there any rules or requirements we should know about?”
You are not alone in wondering this. Judging by the emails we receive from our readers, a lot of folks who are planning to use an FHA loan to buy a home are concerned about their credit card debt. And rightfully so.
Some of the most common questions we receive:
- Can I get an FHA loan with credit card debt?
- What’s considered to be too much debt, from a mortgage standpoint?
- What are the FHA requirements for documenting credit card balances?
We will address all of these questions here today, and then some!
Can I Get an FHA Loan with Credit Card Debt?
The short answer is yes, it’s entirely possible to qualify for an FHA-insured mortgage loan with credit card debt.
In fact, it could actually work to a person’s advantage. This is especially true for those who pay their bills on time, every time. A pattern of timely payments shows lenders that you are a responsible borrower. It can also improve your credit score and make it easier to qualify for an FHA loan.
On the other hand, carrying too much credit card debt could hurt your chances of qualifying for an FHA loan. If a person is already “buried” in debt, a mortgage lender would be reluctant to give them a home loan.
So, the amount of credit card debt you currently have is one of the most important factors, when it comes to qualifying for an FHA loan.
Your payment history is also important. We touched on this above. People who pay their bills on time tend to have better credit scores. This works to their advantage when they apply for additional financing, whether it be a mortgage or an auto loan.
The All-Important ‘DTI’ Ratio
The size of your outstanding credit card balance can affect your ability to qualify for an FHA loan. That’s because it contributes to your debt-to-income ratio, or DTI. This is one of the things mortgage lenders look at when reviewing applicants for home loans. This is true for both FHA and conventional mortgages.
As you might have guessed, the debt-to-income ratio is simply a comparison between the amount of money you earn each month, and the amount you spend to cover your recurring monthly debts. For instance, if you used about one-third of your gross monthly income to cover your recurring debts, you’d have a DTI ratio of around 33%.
This ratio is important to lenders because it gives them a sense of how much debt you have, and also whether or not you are a good candidate for a home loan. Statistics show that people with a higher-than-average debt load are more likely to default on their mortgage loans. And that’s perfectly logical, when you think about it.
We have a separate article that talks about the debt-to-income ratio requirements for FHA loans. The short version is that if your DTI ratio exceeds 50%, you might have a hard time qualifying for an FHA loan.
So this is one of the ways that credit card debt can affect the FHA mortgage qualification process. If you have a fairly high balance, it might push your DTI ratio above the lender’s limits for a mortgage loan. On the other hand, if you have a manageable level of debt, it might not be an issue at all. It’s the amount that matters most.
How It Affects Your Credit Score
Your credit card debt and payment history can also affect your credit score. Mortgage lenders often look at a person’s FICO scores, in particular, which range from 300 to 850. A higher score is better, when it comes to applying for an FHA loan.
There are several factors that can influence a person’s credit score. The biggest factor is their payment history. In this context, we’re talking about recurring debt obligations such as credit cards, auto loans, personal loans, etc.
People who have a history of making all of their payments on time tend to have higher scores. On the other hand, those who have a pattern of missed or late payments tend to have lower scores.
Do you keep up with your card balances? Do you make your payments on time? If so, your credit card usage could actually improve your score and help you qualify for an FHA loan. However, if you’ve missed quite a few payments in the past, you might have a harder time qualifying for an FHA-insured mortgage loan.
Did you know? According to current HUD guidelines, borrowers need a minimum “decision credit score” of 500 or higher to be eligible for the FHA loan program. To qualify for the 3.5% down-payment option, borrowers need a score of 580 or higher.
So those are two of the ways credit card debt can affect you when applying for an FHA loan — or any other type of mortgage product for that matter.
- The amount of debt you have matters, because it affects your DTI ratio.
- Your payment history matters because it affects your credit score and shows lenders how you have managed your debts in the past.
Basic Documentation Requirements
The FHA loan program is managed by the Department of Housing and Urban Development, or HUD. And they have specific guidelines and requirements for documenting credit card debt within an FHA loan application. Those guidelines can be found in HUD Handbook 4000.1, also known as the Single-Family Housing Policy Handbook.
The term “credit card” isn’t used very much within the handbook. Instead, it refers to “revolving charge accounts.”
A revolving charge is when a lender extends credit to you on a monthly basis. You can use as much or as little as needed, within a certain limit. Toward the end of each month, you receive a bill and the unpaid balance “rolls over” to the next month. Credit cards are the most common type of revolving charge account.
For an FHA loan, mortgage lenders must document the amount of credit card debt a person has at the time of application. Here’s an actual quote from the handbook:
“The Mortgagee [i.e., lender] must include the monthly payment shown on the credit report for the Revolving Charge Account. Where the credit report does not include a monthly payment for the account, the Mortgagee must use the payment shown on the current account statement or 5 percent of the outstanding balance.”
But we’re getting into the weeds here. The key takeaways from this lesson are:
- It’s certainly possible to qualify for an FHA loan with credit card debt.
- The amount that you owe is important, because it contributes to your total debt-to-income ratio.
- Having too much credit card debt could make it harder to qualify for an FHA loan, because it makes the loan riskier for the lender.
- How you have managed your payments in the past can also affect you, for better or worse.
Disclaimer: This article includes current trends and standards within the lending industry, which are not always set in stone. Your experience may differ from the examples cited here. The only way to find out where you stand, in terms of FHA loan qualification, is to speak with a lender.