FHA loans are one of the only home loan options available for people who have less than ideal credit, so many people assume they don’t need to improve their credit before applying for an FHA home loan. However, there are significant benefits to having your finances and credit in order before you apply for an FHA loan. 

Do I Need to Improve My Credit Before Applying for an FHA Home Loan? 

While you can technically qualify for an FHA home loan with a credit score of 500, it will be incredibly hard to find a lender. Although the Federal Housing Administration backs the loan in case you default, each lender has their own qualifications and stipulations. With a credit score of under 580, even if you can find a lender, you will need to increase your down payment to at least 10%. If you were drawn to FHA home loans because of the low down payment options, you should build your credit until it reaches at least 580. If you have a high debt to income ratio, you will want to increase your credit until it is at least 620, when debt to income ratios are allowed to be higher. If at all possible, it is best to have a score of 620 or higher in order to get the best terms on your FHA loan. 

Use Free Credit Monitoring 

One of the easiest ways to improve your credit score is to simply be aware of what’s on it. By using a free credit monitoring service, you will be able to see what is impacting your score, any delinquent accounts, and track your improvements. You can also typically dispute charges within the credit monitoring service, which makes improving your credit score even easier. 

Dispute Any Questionable Charges 

Disputing questionable charges is free, and relatively easy to do while you are tracking your credit score. When you dispute charges that may be fraudulent or incorrect, they may drop off your credit report, significantly improving your score. If you dispute a charge, unless it is considered frivolous, the information provider must update or delete the disputed item if any errors or missing information is found. Disputing questionable charges is the first action you should take when you are improving your credit score. 

Reduce as Much Old Debt as Possible 

If you have any high impact debt that is not going to fall off your credit report any time soon, you should consider making an attempt to pay it or make a settlement in order to improve your credit score. 

Make All Your Payments on Time

Always make payments on time. If you cannot make a payment in full, pay at least the minimum amount so it doesn’t affect your credit score. Over time, making payments on or before the due date will improve your credit score. 

Keep All Old Credit Accounts 

If you have old accounts that you don’t use in good standing, you might think that closing them would improve your credit, but the opposite is true. The age of your credit history accounts for 15% of your overall score. This means that if you have old accounts that you don’t use, it is better to keep them open, so that they can continue to improve your credit score.  

Don’t Apply for New Credit Lines Immediately Before Applying 

If you know you are about to apply for an FHA loan soon, don’t apply for new credit lines to try to improve your credit. Immediately after applying, your credit score will go down due to a new inquiry. If you need to open a line of credit, try to do so 6 months or more before submitting your FHA loan application. 

Keep Your Debt-to-Income Ratio Low 

There are limits on the debt to income ratio you’re allowed to have to get approved for an FHA loan. In addition, your credit score will go down when you have a high debt-to-income ratio. If you have a credit score below 620, you will be required to have a lower debt-to-income ratio (another reason to wait until your score reaches at least 620 to apply). Even if your score is above 620, your debt-to-income ratio cannot exceed 57%. 

If You Have Time, Get a Secured Credit Card 

If you aren’t applying for an FHA loan in the near future and you have a sub-500 credit score, or you want to take extra time to build your credit before applying for an FHA home loan, a secured credit card is a quick and easy way to begin building or rebuilding your credit. By putting a deposit down, you are able to get approved for a credit card that reports to the credit bureaus each month. If you get a secured credit card and use it sparingly, it will not only increase the amount of on-time payments you have, but also lower your debt-to-income ratio. 

Try to Save for Your Down Payment 

While FHA loans are known for their low down payment options, the bigger the down payment you have, the better, especially if you have a lower credit score. If you have a down payment of under 10% you will have to pay mortgage insurance over the life of the loan, or until you refinance. If you pay over 10%, you will only pay mortgage insurance for 11 years, or until you refinance. That can save you a significant amount of money over the life of the loan. When you reach 20% equity, you may be able to refinance without having to pay mortgage insurance at all. 

So, What’s the Bottom Line? 

In essence, you will want to try to build your credit score to at least 620 if possible, and save a down payment as large as you can afford. This will get you the best possible terms and save you the most amount of money over the life of the loan, or until you refinance.