FHA loans with low credit: what scores 500 to 579 mean

Which score counts

FHA uses a "minimum decision credit score." HUD Handbook 4000.1 describes how it is chosen: when the lender pulls scores from the credit bureaus, it uses the middle of three scores or the lower of two for each borrower. When there are several borrowers, it uses the lowest of those results. If some borrowers have no score at all, the lender uses the lowest decision score among those who have one.

So a strong co-borrower does not lift a weak score. The weakest scored borrower sets the band.

The three bands

HUD's rules divide applicants by that decision score:

The loan-to-value is figured on the lower of the price and the appraised value. The FHA upfront mortgage insurance premium is usually added to the loan on top of these figures, and closing costs are separate.

Manual underwriting and tighter ratios

Most FHA loans are evaluated first through FHA's automated scorecard. When a file is downgraded to a human underwriter, or must be manually underwritten for another reason, HUD sets maximum ratios by score. For borrowers whose lowest decision score is 500 to 579, or who have no score, the limits are 31% for the housing payment and 43% for total monthly debts, measured against gross monthly income. HUD's table allows no compensating factors to stretch those limits for that band, apart from slightly higher limits for qualifying energy-efficient homes.

Borrowers at 580 and above can go higher on a manual file if they have documented compensating factors such as cash reserves or a minimal increase in housing payment.

In practice, that means a low-score buyer may need a lower price, lower other debts, or both. Use the CFPB's definition of debt-to-income, total monthly debts divided by gross monthly income, to check where you stand.

Lender rules on top of FHA's

HUD's FHA myths-and-facts sheet notes that FHA-insured mortgages have a lower minimum credit score requirement than most conventional mortgages. That minimum is the program's floor, though, not a promise from every lender. Lenders can apply their own stricter standards, and those standards differ from one lender to the next. If one lender turns you down at 560, another may not, and a third may tell you exactly what score would change the answer. Shopping is worth the effort.

Strengthening a low-score file

If you are in the 500 to 579 band, these steps can help:

1. Check your reports for errors. Free copies are at AnnualCreditReport.com. An incorrect late payment or a debt that is not yours can cost points. Dispute errors in writing.
2. Bring card balances down. Revolving balances relative to limits weigh heavily in scores.
3. Keep every payment on time from now on. Recent history counts more than old history.
4. Do not open or close accounts just before applying. New inquiries and changed limits can move scores the wrong way.
5. Document strengths. Proof of on-time rent and savings left after closing support a manual review.
6. Avoid credit repair companies that promise to remove accurate negative items. Accurate information can generally stay on your report for years; only errors can be removed through disputes.

Sometimes the best financial move is to wait a few months. Crossing 580 can cut the required down payment by more than half and open higher debt limits on a manual file.

When FHA still makes sense below 580

If you have 10% saved and steady income with low other debts, an FHA loan in the 500 to 579 band can work. The bigger down payment also lowers your loan and builds equity from the start. Ask the lender for a Loan Estimate and compare the rate and mortgage insurance with any other options available to you.

The bottom line

Under FHA rules, below 500 is ineligible, 500 to 579 needs 10% down and, on a manual file, ratios no higher than 31/43, and 580 or above opens the 3.5% minimum. Know your decision score, check your reports, and if 580 is close, a few months of focused credit work may save you thousands in cash at closing.