203(b) Loan Requirements for Borrowers
There are a variety of requirements necessary for borrowers interested in taking advantage of the FHA 203(b) loan program. Here, we’ll take a close look at those requirements to help you understand if you qualify.
Credit Score
While VA loans do not require any credit score, you’ll find that FHA mortgages have some of the most lenient requirements of all. Conventional loans are only available if you have a credit score of at least 620. However, with an FHA loan, you can have a credit score as low as 500. However, remember that scores under 580 will require a higher down payment.
It should also be noted that while FHA loans are available for those with low credit, they are NOT available for those with “bad” credit. That is, you can apply with a low credit score, but there must be a qualifying reason or situation for your score to be so low. FHA loans are not available for those who have damaged their credit score through carelessness or negligence. If you have a credit score under 500, you do not qualify for the FHA 203(b) loan program.
What sorts of situations might qualify you to apply for an FHA loan even if your score is from 500 to 579?
High utilization: You use most of your available credit in one form or another.
Blemishes: Financial mistakes (such as previous bankruptcies) in your past can lower your score, but may not disqualify you from applying for an FHA loan.
Little credit: If you have no credit, or have a very short credit history, you may still qualify for an FHA 203(b) loan.
Too many accounts: Lots of accounts can drop your credit score, but do not necessarily mean that you are a high-risk borrower.
Not sure if you measure up? Worried that your low credit and some past blemishes might prevent you from taking advantage of this loan program? Here’s what HUD has to say about credit history: “Borrowers who have made payments on previous and current obligations in a timely manner represent a reduced risk. Conversely, if a borrower’s credit history, despite adequate income to support obligations, reflects continuous slow payments, judgments, and delinquent accounts, significant compensating factors may be necessary to approve the loan.”
In short, even if you have low credit, as long as you have a record of making timely payments and enough income to meet your obligations, you should be able to apply for an FHA 203(b) loan.
In addition, if you have no credit history at all, the FHA/HUD mandates that lenders work to create an alternative financial picture of your creditworthiness. This can be done by analyzing things like your phone bill, electric and other utility bills, cell phone bill, and other regular payments that act like credit, but that do not establish credit.
Down Payment
The need for a sizable down payment can make it seem like buying a home is out of the picture. Conventional loans require that you have at least 20% of the home’s value to use as a down payment. Otherwise, you’ll have to purchase private mortgage insurance (PMI). And, with the cost of homes hitting all-time highs across the country, that can be an incredibly large chunk of change.
With an FHA 203(b) loan, you don’t need to worry about that so much. If your credit score is 580 or higher, then you will only need to come up with 3.5% of the purchase price. That’s one of the lowest down payment requirements out there. To illustrate the point, a home with a $200,000 price tag would require just $7,000 down.
Of course, even 3.5% of a down payment can be an insurmountable hurdle, but the FHA allows a number of funding sources to be used to obtain that amount, including the following:
Financial gifts from family members, government agencies, and even employers. However, anyone with an interest in the home, such as the seller, is prohibited from providing a gift. Also note that cash gifts must have a paper trail that can be verified during the underwriting process.
Personal savings. However, the savings must be documented for around 60 days before they can be used. The account holding the funds must also be around 60 days old to prevent red flags.
The sale of other assets owned by the borrower. However, proof of ownership may be necessary to satisfy the lender that you (the borrower) have a right to sell the asset.
However, if you have a credit score lower than 580, you will not be eligible for the 3.5% down payment. Instead, you’ll need to come up with 10% of the value of the home. That would be $20,000 if we use the same $200,000 home example we used above.
Debt-to-Income Ratio
In order to be eligible for an FHA 203(b) loan, you must not have a debt-to-income ratio higher than 43%. That is, your gross monthly expenses cannot account for more than 43% of your gross monthly income. For example, if you earned $50,000 per year, your gross monthly expenses could not exceed $1,791.67 per month. This would include any recurring expenses, such as:
● Auto loan payments
● School loan payments
● Utility payments
● Insurance payments
DTI calculations do not include discretionary expenses, such as paying for gas in your car, or buying groceries for the family.
Income and Employment
You must be able to show proof of income and ongoing employment. Generally, you only need a year of employment with the same company, but the lender may require things like a letter of employment to prove that you are indeed employed in the position that you claim. You’ll most likely need to show several months’ worth of paycheck stubs, as well as your tax returns for the preceding couple of years.
Closing Costs
Closing costs are often unexpected sources of financial grief during the home buying process. They usually cost up to about 4% to 5% of the value of the loan, and must be paid before the loan can close and you take possession of the home. With an FHA 203(b) loan, you are allowed to ask the seller to pay up closing costs up to 6% of the value of the home, but no more. Other parties are also allowed to pay some of your closing costs, but the 6% contribution limit remains in place.