Credit Score Below 500? No FHA Home Loan

The door that was once wide open to homeownership closed a bit recently when a key government agency announced a proposal to no longer allow mortgages for borrowers with credit scores below 500.

The Department of Housing and Urban Development (HUD) said that it intends to require borrowers to have scores of at least 500 to qualify for FHA-insured loans. The agency has not required a minimum score before.

The practical impact of this move will be extremely limited; during the second quarter of 2010, no FHA-insured loans were issued to borrowers with sub-500 scores. And, in fact, less than 1% of borrowers were below 580; most loans went to borrowers with scores above 620.

HUD has been expressing increasing concern over default risk in the wake of the housing bust. The percentage of delinquent FHA loans has trended up, as have rates for virtually all mortgage loans.

The FHA had earlier proposed steps to reduce delinquencies and so therefore cut risks. One was to raise the minimum downpayment to 10% for borrowers with credit scores below 580.

Another was to reduce allowable seller concessions to no more than 3% of the sale price. That would force buyers to make more of a financial commitment to their home. It is generally believed that given more "skin in the game," homeowners are less likely to default.

These policies are all still in the proposal stage. Before going into effect, the department is soliciting public comment on the matters for 30 days. Then, it will evaluate the comments before implementing any changes.