EDITORS NOTE 12/13/2012: This post was written in 2008 and currently, our company (and many others) will not consider “alternative credit”. We now have a minimum credit score of 640 required.

FHA insured loans, which are quickly becoming the mortgage of choice unless you have 20% down payment and 720 credit scores, allows people to obtain mortgage financing if they are shy on an established credit history reported to the credit bureaus.  Typically, a borrower needs to the following shown on their credit report for it to be considered “established”: 

• At least three trade lines (credit accounts) in good standing.
• Two of the three trade lines must be at least 12 months old.
• One trade line must be at least 24 months old.
• Three credit scores per borrower.

Sometimes, if someone does not have established credit that is reported to the credit bureaus, they need to use “alternative credit” or “non traditional” credit, which may be acceptable with FHA financing.   Proving you have credit that is not reported to the bureaus requires that you obtain documentation from three different sources that you have made on time payments to during the last 12 months.   

Possible types of non-traditional credit (preferred–at least one of these types of sources are required):

• rent payments
• utilities (telephone, electricity, gas, water, garbage, cable, etc.)–not included in housing payment.

Other acceptable sources of non-traditional credit are (two out of three sources may come here):

• insurance (medical, auto, life, renter’s, etc).
• payment to child care providers
• internet/cell phone service
• personal loan with terms in writing supported with canceled checks
• department, furniture, rent-to-own stores, etc.
• a documented 12 month history of saving by regular deposits (at least quarterly) that are not payroll (automatic) deducted.

Note:  Debts that are paid automatically from your payroll are not allowed to be used in documenting non-traditional credit.  Lenders want to make sure that you are able to make timely payments “voluntary”.

The “form of proof” can be:

• canceled checks for the last 12 months, or
• written letter from creditor which is written on their letterhead, includes your name and account number stating the you have made on-time payments during the last twelve months.   The letter should include what the payment amount is and the total amount due.

In order to qualify for a non-traditional credit approval with FHA, over the last 12 months, there must be:

• No late payments for housing.
• No collections or court records reporting (with the exception of medical).
• No more than one 30 day delinquency on payments due to other creditors.

Qualifying ratios are restricted to 31% for the payment to income ratio and 43% for the total debt to income ratio.   Two months reserves (two months mortgage payments in savings after closing) is also required.  When non-traditional credit is used, the mortgage is a “manual underwrite” meaning that you need to allow for more time during the underwriting process as a real live human is underwriting your transaction.   

Last but not least, do make sure that you are working with a Mortgage Professional who is qualified to provide FHA mortgage loans.  Not all mortgage companies are approved and, with many products no longer available, they may try to illegally provide an FHA mortgage with hopes of finding another lender to broker it to.  Ask your Mortgage Professional if they have provided FHA loans before, how long and how long their company has been approved for FHA loans.  By the way, I cut my mortgage teeth on FHA 8 years ago and our company has been providing FHA loans since our inception.  (We are a Direct Endorsed HUD lender).  You can always check out HUD’s site to confirm whether or not your lender is approved.

Questions or concerns about FHA (or any) mortgages for Washington State properties?  Contact me.

Cindy, one of my clients that I helped finance their first home, emailed me this question:

"I know home loans have changed a lot but is it true that you can’t get a home loan with a credit score under 700 and 20% down?"

Not true.  Although I’m sure it feels that way and I’ve even heard some in the media make similar wrong statements…it’s no wonder you would have this question.

Having a high credit score and significant down payment certainly doesn’t hurt a home buyer.  It is true that many of the mortgages of recent years are no longer available.  And actually a 700 credit score pays more for their interest rate than someone with a 720 credit score now.   Conventional underwriting guidelines continue to tighten during these historic times.

FHA continues to be a very strong option for home buyers and home owners needing to refinance.   Even when FHA begins to implement risk based pricing for mortgage insurance, as reported by Kenneth R. Harney, borrowers can still have 3% down and lower credit scores:

"On 30-year mortgages with down payments of 10% or more, applicants with FICO scores above 680 will qualify for the lowest premiums — 1.25% of the loan amount upfront and annual renewal premium payments of 0.5. Borrowers with down payments of less than 5% and poor credit scores — FICOs ranging from 500 to 559 — will be charged premiums of 2.25% up front and 0.55% annually. All borrowers will continue to receive the same market-based interest rate. Under the current system, borrowers pay uniform 1.5% premiums upfront and 0.5% annually."

One thing to keep in mind is that borrowers do need to have clean credit (no lates) for the past 12 months.  And even if FHA allows a 500 credit score, many lenders have their own underwriting guidelines that may not allow it and they have higher rates for lower credit scores.

To learn more about FHA, please check out my FHA Resource Center or contact me.   Mortgage Master is proud to have our Full Eagle.  We are a direct endorsed HUD lender…what does this mean to you?   We have an FHA underwriter on site at our King County office…we’ve been providing FHA insured mortgages to Pacific Northwest families for over 30 years.