Finance

How to Get an FHA Loan with Bad Credit

March 27, 2023

If you’re stressed out over qualifying for a loan based on poor credit history, then you’re smart to investigate FHA loans as an option. Mortgage loans insured by the Federal Housing Administration (FHA) are intended to allow more low-income borrowers who don’t meet conventional mortgage lender requirements to buy and/or renovate homes.

Compared to conventional loan options and refinancing, it’s easier to qualify for an FHA loan with bad credit. But how low is too low for a credit score when it comes to an FHA home loan? What other factors will help or hurt your chances to buy a house or take out an FHA loan to fix up your current home?

Ahead, we’ll walk you through all the details on how to get an FHA loan with bad credit.

Who Is Eligible for an FHA Home Loan?

Before we provide a list of qualifications, it’s important to understand the difference between FHA and lender guidelines. The FHA works behind the scenes to insure your FHA mortgage with the lender, but your mortgage loan is a contract between you and your bank, credit union, or other mortgage provider.

So, who qualifies for a 203(k) loan? The FHA borrower requirements include:¹

Minimum credit score of 500

With compensating factors, debt-to-income ratios (DTIs) can be as high as:
- 40% for front-end DTI (monthly mortgage payments ÷ gross income)
- 50% for back-end DTI (monthly debt payments ÷ gross income)

Down payment minimums are as follows (and can be funded via gift or grant):
- 3.5% for credit score 580 and above
- 10% for credit score 500–579

Stable, sufficient income (a guideline to be interpreted by each lender)

A good debt payment history for at least 12 months or acceptable explanation why not

How Hard Is It to Get an FHA Loan with Bad Credit?

You’ll be challenged to find a lender or loan officer who’ll offer you a mortgage with a low down payment at a competitive rate if you have a low credit score and a high debt-to-income ratio.

The FHA guidelines above are the most lenient that lenders are allowed to offer, but most lenders set their own requirements, which are almost always stricter than the FHA:²

The minimum credit score is rarely 500—many start at 580, with some as high as 680.
Front-end DTI maximums may be closer to 28–31% (monthly mortgage payments ÷ gross income).
Back-end DTI maximums may be closer to 36–43% (monthly debt payments ÷ gross income).

It’s not impossible to get an FHA loan with a bad credit history or low credit score, but you may need to explain past credit problems and have other positive factors in your financial picture that counterbalance it. If your credit score is under 600, lenders will likely want to see low DTI ratios, one to two years of timely debt repayment histories, and a stable projected income.

Steps to Getting an FHA Loan with Bad Credit

There is no one magical answer for how to get an FHA loan with bad credit, but there are steps to help you get “approved” stamped on your loan application. You can:

Build a Good Credit History

While it may take time for big changes, some actions can improve your credit score fairly quickly. Look up your credit reports and take these steps where possible with your budget:

Dispute any credit report errors
Pay bills on time going forward
For accounts you’ve neglected, negotiate with lenders to get back on track
Pay off or negotiate with agencies on any accounts in collections
Ask for higher limits and pay down cards to get utilization under 30% of each card limit³
Set up automatic payments, and consider paying biweekly instead of monthly
Become an authorized user of a relative’s card with a high limit and good history

Contact an Experienced, Approved Lender

At their heart, FHA loans are built around extending the opportunity for home ownership or improvement to those who may not qualify for a traditional loan. Many FHA borrower eligibility guidelines have exceptions that can help borrowers with unique situations pass the loan underwriting process.

When you’re looking for lenders, inquire about how much experience the person you speak with has, and check out the lender’s FHA loan history online.⁴ Not every lender handles FHA loans, and among those that claim to, you may come across mortgage providers or individual loan officers who aren’t well-versed in the process.

Shop Around

Don’t let a less-than-ideal credit picture leave you feeling powerless—at the end of the day, you’re still the consumer, and the lender will be making money off of your loan. While you may have fewer lenders to choose from, don’t skip the comparison shopping stage. Carefully consider the pros and cons of a 203(k) loan.

Lenders may interpret FHA guidelines differently, since much of the wording allows rather than requires them to make exceptions, allow for variances, and provide flexibility in working with challenging loan applications. Be prepared to make lists, ask questions, and make requests as you review lenders online or by phone.

Provide Supportive Documentation

If part of your loan application includes providing clarity about a rocky credit history or debt load, you’ll want to be prepared with any documents that shed light on the details. These may be documents that show evidence of circumstances in your life and family, such as medical records, a death certificate, or divorce filings.

Additional support could come from documenting:

Future income potential related to your education or anticipated career trajectory
Supplemental income such as bonuses, commissions, and overtime
Similar income projections and plans for a spouse
A budget plan and process
Intent to utilize Energy Star home appliances and construction options for utility savings
An emergency cash fund that can cover three to six mortgage payments
A savings plan with regular deposits to retirement, investment, and/or bank accounts

Get Pre-Approved

Talk to lenders, comparison shop, and go through the qualification process to receive a letter of pre-approval if you’re applying for a homebuyer FHA loan. In addition to improving your chance at having a bid approved by a seller, it’ll allow you more time to work with your lender on credit history concerns.

Increase Your Down Payment

FHA guidelines require a higher down payment of 10% (rather than 3.5%) for borrowers with a credit score from 500–579, but you can boost your chances of a loan approval with a bigger down payment regardless of your exact score.

Remember, your loan application is not just to get a yes or no answer from the lender—it also determines what interest rate you’re offered. To a lender, a larger down payment equals a higher level of personal financial commitment by a borrower, and it’s an important factor that can help balance out a poor credit history.

With an FHA loan, your down payment can be provided by outside sources. See what you can afford or request from:

Gifts from family or friends
Down payment assistance programs from state and local agencies and nonprofits, including:
- Direct and matched-savings grants
- Forgivable loans at 0% interest so long as you live in your home for a set period
- Deferred-payment loans at 0% interest, payable only when you sell or refinance
- Low-interest loans

Consider Alternative Options

An FHA loan can either fund a new home purchase or refinance a current home in need of renovation, but it’s not the only game in town.

Prospective homebuyers can also consider:

First-time homebuyer loans with 3% down payment from Fannie Mae or Freddie Mac
USDA mortgages
VA home loans for veterans
Seller-financed sales (be sure to do the research and protect your rights)

Current homeowners looking for renovation financing can consider:

A home equity loan or home equity line of credit (HELOC)
Cash-out refinancing
Personal loans or credit cards
Residential sale-leaseback programs (a debt-free alternative)

Residential Sale-Leaseback: A Better Solution

If you’re a homeowner considering an FHA limited or standard 203(k) or Title 1 renovation loan, you may want to explore a residential sale-leaseback program as an alternative.

Residential sale-leasebacks provide homeowners with the security of remaining in their home as long as they choose plus the opportunity to convert your home equity to cash. There are many sale-leaseback benefits. With a dependable residential sale-leaseback buyer and service provider, you get:

All of your home equity in cash
A sale instead of a new interest-bearing debt
The legal right to stay in your home as a renter as long as you choose
A rent payment you agree with and limits on future increases in writing
Someone else to handle the work and cost of covered repairs and maintenance

Plus, unlike an FHA loan, a residential sale-leaseback leaves you with:

No limits on how you use your money
No more property tax or homeowner’s insurance payments
No private mortgage insurance added to monthly housing costs

Key Takeaways

Although FHA loans are designed to help those who would otherwise not qualify for mortgages tackle and maintain homeownership, a poor credit history can still be a roadblock—particularly if your credit score is under 580. Finding a skilled FHA mortgage broker or lender, boosting your credit score, paying down debt, and saving for a larger down payment are some of the steps to overcoming bad credit.

Be sure to consider all options, particularly if you’re a current homeowner seeking an FHA refinance or renovation loan. Converting your equity to cash such as with a residential sale-leaseback program is an alternate route to financing home improvement without incurring new high-interest debt.

Sources:

Wood, Kate and Badach Doyle , Abby. “FHA Loan Requirements for 2023.” Nerdwallet. February 7, 2023. https://www.nerdwallet.com/article/mortgages/fha-loan-requirements
Curry, Sheree R. “Understanding FHA Loan Requirements, Down Payments & More.” MonkeyGeek.com. December 12, 2022. https://www.moneygeek.com/mortgage/fha-loan/requirements/
O’Shea, Bev. “How to Improve Credit Fast.” Nerdwallet. November 1, 2022. https://www.nerdwallet.com/article/finance/raise-credit-score-fast
“HUD Lender List Search.” U.S. Department of Housing and Urban Development. https://www.hud.gov/program_offices/housing/sfh/lender/lenderlist