Buying a new home is exciting, but it is important for a prospective buyer to know how his financial situation might affect the terms of his loan. If a borrower applies for a Federal Housing Administration loan, he should understand how his credit score might affect the interest rate offered by the lender.
What Is an FHA Loan?
If a borrower is unable to qualify for a standard mortgage loan, he can apply for an FHA loan instead. With an FHA loan, the borrower must secure mortgage insurance, which protects the lender in case of default and improves the borrower's chances of approval. An FHA loan commonly has less stringent standards for approval compared to a standard loan, though the applicant must still meet basic qualifications in terms of debt-to-income ratios and credit history. Most FHA loans have a fixed interest rate, but in some rare cases, the lender may offer adjustable rate loans.
Credit Score Effect
The credit score of the applicant does have an effect on the interest rate for an FHA loan. An applicant with a score at or above the average score of 690 for an FHA loan (as of 2010) commonly gets the best rates while lower scores of 600 (minimum as of 2010) get offers for higher interest rates. The rates fluctuate and vary depending on the program packages offered by each lender.
Other Factors
The applicant's credit score also affects the down payment required for the FHA loan. A low-end score usually equals a higher down payment. A lower score presents a higher risk for the lending institution, so the prospective buyer must invest more into the house upfront in order to get the mortgage loan. On the other hand, an applicant with a higher score can pay a down payment closer to the FHA minimum (about 3.5 percent as of 2010).
Improving Credit Rating
Once the borrower initiates the process of getting an FHA loan, it isn't likely he'll be able to improve his score at that point to get a better interest rate. For that reason, it is important for a prospective borrower to take steps to raise his score as much as possible months before contacting an FHA approved lender. Resolving unpaid debts, reducing running debt balances, catching up with late payments and resolving errors on a credit report are a few ways to improve a credit rating.
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