How do Lenders Evaluate Bad Credit FHA Loans?

There are some misconceptions as to whether the FHA issues bad credit loans. The short answer is "no." First, the FHA does not issue loans directly; instead, it provides a guaranty service for private loans. Second, the FHA has high credit standards required of any applicant seeking a guarantee. The confusion over bad credit FHA loans comes from the fact the organization does attempt to assist lower income individuals or first time home buyers through unique programs.

Structure of an FHA Guarantee

An FHA guarantee is like insurance on a private loan. A borrower takes a loan from an institution such as a bank or mortgage company privately. If the borrower is approved for an FHA guarantee, the FHA forms an agreement with the lender. This agreement is a promise the FHA will assume the loan if the borrower defaults. With this security, the private lender agrees to lower the cost of ownership by reducing items such as interest rates and private mortgage insurance requirements. As a result, the borrower benefits if he or she qualifies for the FHA's guarantee program.

FHA Guarantee Credit Requirements

The FHA is on the hook if a borrower defaults on a loan. For this reason, the FHA wants to make sure there is a very low chance of default before approving a guarantee. The FHA uses the same process as private lenders to determine the likelihood a borrower will pay: a credit check. An FHA borrower cannot have a record of foreclosure or bankruptcy. Further, the borrower must not have delinquent debts due to the Federal government. Finally, the borrower must have a credit record that shows responsible payment activity on all current and past debts. If a borrower fails to meet any of these requirements, the borrower will not likely be considered "creditworthy" to the FHA.

Help for Low Income Individuals

Fortunately, the FHA does overlook some items that private lenders may use as grounds for disqualification for a mortgage. Because the FHA is charged with extending homeownership to all individuals, the organization aims to help those parts of the population that are full of creditworthy individuals who may not meet income requirements. For example, a teacher in an urban may have a great record of payment on debts but have a moderate to low income. The FHA could assist this teacher by offering low cost mortgage insurance and a fixed rate loan.

Help for First Time Home Buyers

The FHA particularly encourages first time home buyers through a number of initiatives. First time home buyers tend to have short credit histories and may struggle coming up with a large down payment. To assist, the FHA guarantee program makes it possible for borrowers to place as little as 3.5 percent down on a home and still receive a fixed rate loan. The important thing to remember is the FHA does not help first time home buyers with poor credit. Instead, it assists those individuals who are credit worthy but may lack the resources for the initial purchase of a property.

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