Credit Scores Needed for VA and FHA Loans

FHA loan, VA loan

By Taylor Milam

In many ways, homeownership is still part of the American dream. There’s something special about owning your own home, taking care of it and changing it as you please. But here’s the deal — the price of homeownership has drastically increased over the years. In fact, according to the latest U.S. Census Bureau report, the median price of new homes has increased from $157,300 in March 1999 to $302,700 in March 2019. In other words, new home prices have nearly doubled in the last twenty years.

Yet despite the price increase, 64% of Americans own a home and many more hope to buy one in the near future. It’s a big purchase though. So once you’ve determined that you’re financially ready to take the plunge and become a homeowner, it’s important to understand your financing options.

Conventional loans might not work for everyone, and many mortgage lenders have minimum credit requirements, so if you have bad credit, buying a home could be even more challenging. For others, the out-of-pocket expenses can prevent them from being able to afford a home.

However, there are programs designed to lower the barrier of entry for home ownership, including Veterans Affairs (VA) loans and Federal Housing Administration (FHA) loans. You can learn more about specific credit requirements for the specific loan programs below.

But first, about your credit score...

Before applying for any type of mortgage, you’ll need to make sure that your credit score is ready for homeownership. According to Experian, one of the three major credit bureaus, you’ll want to make sure that your score is at least above 500:

“FICO Scores range from 300 to 850, which are then divided into five score ranges: Very Poor: 300 - 579 Fair: 580 - 669 Good: 670 - 739 Very Good: 740 - 799 Exceptional: 800 - 850 The higher your score, the more options you'll have for credit, including home loans. If your score is below 500, you might not be able to get approved for a home loan and may have to focus on building your credit first.”

If you have bad credit, consider waiting to purchase your home until after you build better credit, which could take anywhere from a few months to a few years, depending on your situation. Having better credit could save you thousands of dollars over the lifetime of your loan, so sometimes it's worth the wait.

The first step to building better credit? Check your credit report to understand why your credit is bad in the first place. For more on how to build credit, be sure to check out our post on "How to Build (or Rebuild) Credit."

If your credit score is in shape though, a VA or FHA loan could be just what you need to gain access to your own real estate.

What are VA loans and FHA loans?

VA Loans and FHA loans are two different types of mortgage loans with specific terms, details and eligibility.

What you need to know about VA loans

VA-guaranteed loans are for active-duty military members, retirees and reservists who meet service length requirements. In some cases, surviving spouses of veterans are also eligible.

As the U.S. Department of Veterans Affairs explains:

“The VA provides policy, guidelines and oversight of the program. Lenders provide financing for eligible Veterans. The guaranty allows Veterans to obtain a loan without a down payment or mortgage insurance (PMI) premiums.”

In other words, the VA guarantees the loan (up to a certain amount) and as a result of that guarantee, lenders do not require VA loan borrowers to provide a down payment or pay PMI.

When borrowers have a down payment that is less than 20% the appraised value of their home, PMI helps to protect the lender in case of default. Because of this, borrowers who have less than 20% as a down payment must pay PMI until the loan-to-value ratio is 80% or less.

In the case of VA loans, the government guarantee serves as the lender’s protection against default. Guarantee amounts vary by state and county, but you can check the specific requirements for your area through the U.S. Department of Veterans Affairs.

This is different from conventional mortgage loans, which usually require a 5% down payment. Plus, conventional mortgage loan borrowers are required to pay private monthly insurance premiums — which is usually 0.5% to 1% of the home’s value annually — until they have 20% equity in the home. In other words, VA loans can help borrowers save a lot of money.

Eligibility

There are a lot of unique ways military members can save money and one of the most popular ways is with a VA mortgage loan.

To find your eligibility, you can apply at ebenefits.va.gov or call 877-827-3702 for more information.

You are able to apply jointly with your spouse and it might be a good idea to do so, but as Brandon Renfro, financial advisor and Assistant Professor of Finance at East Texas Baptist University explains, there are some limitations:

“If you apply jointly with your spouse then both of your credit scores, incomes and debts will be considered in the application. If your spouse has a stronger application then you may want to include them. But you can’t only use your spouse’s credit score unless your spouse is also eligible for a VA loan.”

Terms and details

Here’s the deal — even if you qualify for a VA loan, you can still be denied for a mortgage.

Renfro explains:

“It is important to remember that the VA isn’t making the loan. The VA is simply guaranteeing the loan to the lender in the case that you default. The financial institution will still do its due diligence. [They] will review your application for a VA loan just like they would for any other type of loan. If your income doesn’t support the loan, your credit history is too bad, or any other common reason, it could result in a denial.”

Credit score

Even though the VA is guaranteeing the loan, your credit score is still taken into consideration for loan approval and interest rate.

“The VA doesn’t set any requirements on a minimum credit score, but the institution you get the loan from likely will. It may be possible to get a loan with scores below the typical range but it isn’t likely. Mid-600’s is a normal minimum score range for most institutions with 620 being the most common minimum,” says Renfro.

The rule of thumb for credit scores is simple: the better your score, the more competitive your interest rate will be.

Other costs

Even though VA loans do not require a down payment or PMI, there is a funding fee.

“[The funding fee] is a percentage of the loan value, either 2.15 or 2.4 depending on your military status, and can either be paid in cash at closing or rolled into the loan. Either way, it is an additional expense of using your VA entitlement. You can also reduce the funding fee by making a down payment instead of the typical 0%,” Renfro says.

What you need to know about FHA loans

While VA loans are restricted only to the military, FHA loans have different requirements. They're sometimes referred to as first-time home buyer loans, since they can be a good "foot-in-the-door" to homeownership for many people

The U.S. Department of Housing and Urban Development (HUD) insures Federal Housing Administration mortgage loans. As a result, the loans are less risky for lenders. Because of the decreased risk, borrowers only need a down payment of 3.5% (compared to 5% for conventional mortgage loans). Plus, borrowers can have lower credit scores. Credit score requirements start at 580 and if you have a down payment of 10%, the credit score requirement drops to 500.

This means that FHA loans might be a good option for first time borrowers with lower credit scores and lower down payments. However, there are notable expenses that come along with this loan type.

For example, buyers have to pay a one-time fee of 1.75% of the home cost at closing. This can often be added to the loan financing. Similarly, buyers who had less than a 5% downpayment have to pay 0.85% of loan total every year throughout the term of the loan. Once again, this can be added to your monthly payments.

FHA loan amounts and requirements vary by state. To learn more about your options, check the HUD.gov state directory.

Eligibility

There are a few eligibility requirements for FHA loans. Here’s what you need to know:

  • Borrowers must have verified income, but there is not an income minimum or maximum.
  • FHA loans are for primary residences. They can’t be used for investment properties that you plan to rent out. As a rule, borrowers need to live in the house for one year.
  • In general, the ratio of your home expenses (mortgage, PMI, insurance, etc.) needs to less than 30% of your gross income. Although there are some exceptions to this requirement.
  • Borrowers usually need a credit score of 580 or higher, but if you have a down payment of 10%, the credit score requirement drops to 500.
  • Borrowers need a down payment of 3.5%.
  • If you’ve had a short sale, you’ll usually need to wait three years before you can get approved for a FHA loan.

It’s also important to note that you can have a cosigner or co-borrower, but it might not be the best idea, according to Casey Fleming, Author of The Loan Guide: How to Get the Best Possible Mortgage.

“It is only a good idea if you can't qualify on your own. However, in my experience if you can't qualify on your own, it might be better to lower your purchase price target, or to wait until you are able to qualify on your own. After all, once you close you actually have to make the payments, too,” Fleming explains.

The FHA TOTAL scorecard is an automatic algorithm that is also used to check borrower credit history and application information.

Fleming explains:

“It uses credit score, down payment, debt-to-income ratio, and liquid assets as the primary risk-related factors and compares them to borrowers of similar profile and their historical performance.

There are times when a borrower might not meet FHA guidelines and so would be turned down for a loan, but Scorecard will approve it anyway.

Why? Well, say that your debt-to-income ratio is too high, but your credit score is outstanding and you have strong liquid assets (lots of money in the bank). The algorithm knows that statistically, you are very likely to make the payments, event if they require an unusually high amount of your income.

Terms and details

There are a few specific things to note about FHA loan rules and requirements.

For example, Fleming explains that a FHA Jumbo loan is a loan that exceeds a county’s limit for a loan in that specific zip code. “Jumbo" is actually used as shorthand for "non-conforming.” "Conforming" means the loan is within the guidelines of Fannie Mae and Freddie Mac, which Congress created.

“FHA loan limits do not necessarily coincide with conforming loan limits. However, for the last eight years or so the loan limits have been the same for FHA and conforming. If you need more money than the FHA loan limit allows, you would need a jumbo loan,” says Fleming.

Even though it doesn’t apply to most borrowers, it’s also important to note that borrowers usually need to pay any court judgements (money you owe someone else as the result of a court ruling) to get approved for a loan.

Credit score

As noted, borrowers with low credit scores can still be approved for FHA loans credit score requirements start at 580 and if you have a down payment of 10%, the credit score requirement drops to 500.

However, keep in mind that your credit score could also impact what kind of interest rates you could be charged too.

Other costs

Fleming says that it’s important to understand the true cost of FHA loans. Because even if they are cheaper up-front, there are other costs that come with these loans.

“FHA loans require both an up-front mortgage insurance premium and an annual premium, paid monthly. Unlike conventional (conforming) loans, FHA mortgage insurance can never be removed, even after you have more than 20% equity in the property. The only way to remove it is to refinance into a conventional loan,” Fleming explains.

How to get started

Making the decision to buy a house is one of the biggest (and most expensive) decisions you’ll make in your life. The second most expensive decision is choosing your mortgage loan. The truth is that there is not a “perfect” loan. Instead, every loan comes with unique pros and cons. That’s why it is important to find the mortgage loan that works best for you and your family.

About the author

Taylor Milam is a personal finance writer who has also written for Credit Karma, Chime, Acorns and Policy Genius, among others.

Written on May 28, 2019

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