FHA Minimum Credit Scores

FHA Minimum Credit Scores

The Federal Housing Administration (FHA) has announced recently the minimum credit scores they will allow on loans they insure will be increased. Effective October 4^th, on all new loans, the minimum score allowed on loans with 3.5% down payment will be 580. Currently FHA will insure loans with a minimum credit score of 500 with 3.5% down payment.

However, most lenders, including Bank of America, are now adjusting the minimum credit score effective October 4th from 580 to 620 with a 3.5% down payment. This is known as a credit overlay in the lending world. So why, if FHA will allow 580, would a lender set the standards higher? The number one reason is the investors that buy pools of mortgage backed securities won’t buy securities if the minimum credit score is below 620 going forward.

Currently, 95% of all home loans closed are backed by Fannie Mae, Freddie Mac or FHA. This means that almost all of the home loans closed are being put into pools of mortgage backed securities and those securities come with some form of government backing to the investors that buy them. The private sector, which is jumbo home loans, does not offer any form of guarantee and therefore no one is buying them. The largest of banks are keeping the jumbo loans on their books and they are known as portfolio loans.

Even with the government backing, investors are fearful of additional short sales and foreclosures therefore they bid on pools that have the highest of standards only. As long as the secondary markets are still not functioning properly the lenders must have credit overlays on government programs in order to sell the pools of loans. While this in turn allows the lenders to raise more capital in order to make new loans, it does keep tighter standards of underwriting than we were used to several years ago.