Finance Roll

For borrowers who are in the market for financing, but don't have the sufficient down payment and higher credit scores to secure conventional financing, a FHA loan may be their best bet. In addition to the upfront mortgage insurance premium (MIP) which can be financed, a minimum down payment of 3.5% and a median credit score as low as 580 is required by FHA. If you can put down at least 10%, FHA will even accept a median credit score as low as 500.

In addition, borrowers will have to pay an annual mortgage insurance premium. This insurance is put in place to protect the lenders interest in the event the property goes into default. This amount is typically rolled into the monthly mortgage payment.

However, because FHA loans are offered by banks, mortgage brokers, savings and loans and credit unions, borrowers will not only need to meet the requirements set by FHA, they will also need to comply with the lender's internal guidelines as well, which are typically more strict than what FHA will accept.

Although a couple of major lenders have recently lowered their median score requirement to 580 which is in line with FHA's current requirements, borrowers need to be careful not to be lulled into a false sense of security. Borrowers who are looking to secure FHA financing also need to be mindful of any number of potential issues that can (and often do) arise when starting with marginal credit scores.

1. The lender's underwriting guidelines can change on a dime.
Lending institutions continuously update their underwriting criteria according to how a particular group of loans perform. If a lender decides to increase their credit score requirements during the processing of a borrower's loan, the loan can still be denied even after a borrower has been preapproved.

2. Lenders may require more documentation that wasn't identified during the beginning of the process.
Lower scores often cause lenders to request more documentation such as more asset information. If the borrower is unable to provide the additional information that they were not made aware of initially, it could not only delay the process, but cause their loan to be declined altogether.

3. Starting with marginal credit scores leaves no room for error.
It's not uncommon for an old charge off, collection or other derogatory item to pop up on a credit report during the loan approval process. For a number of reasons, lenders often rerun credit during the processing of a loan before it closes as an added precaution. If the borrower's scores have dropped below the median score required during the processing of the loan, their loan could go from approved to denied in a blink of an eye.

4. The likelihood of getting approved by another lender will be significantly diminished.
When applying for financing, borrowers need to take into consideration that their credit scores will decrease during the process. If their credit scores are already on the fence, just having another lender retrieve credit can cause the loan to fall flat. In the event borrowers need to take the loan to another lender, having better credit will provide a cushion from derogatory changes that could appear on their credit profile during the processing of the loan.

The reality is it's not just enough to be approved for a FHA loan. In addition to meeting the lender's as well as FHA's criteria, borrowers will also need to be able to maintain their approval status throughout the loan process in order to secure financing. For borrowers with marginal credit who are interested in obtaining FHA financing, taking the time to increase your scores before attempting to secure financing is crucial.

Having better credit also puts borrowers in the position to qualify for a lower interest rate, not to mention that having increased credit scores will make the process of obtaining a loan go much more smoothly. In today's world, when it comes to acquiring financing, an ounce of prevention is worth a pound of cure.