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Can FHA Interest Rates Change Based on Credit?

by K.C. Hernandez

The Federal Housing Administration seeks to make home ownership a reality for borrowers with credit challenges and modest income. FHA mortgage insurance provides participating lenders with a measure of protection in the event you default, making it possible to finance riskier borrowers. The FHA has forgiving credit guidelines when it comes to low scores and previous credit mishaps. Lenders, however, determine whether you qualify for an FHA-backed loan and the interest rate you receive.

Credit Score Tiers

There is no standard scale for determining your interest rate based on credit scores, but you can estimate a score by examining where your credit currently stands. Lenders base your interest rate on the amount of risk you present. They place scores into tiers, with ranges of 19 points to 90 points. For example, the lowest tier for FHA loans usually contains scores between 620 and 639, while the highest tier contains scores ranging from 760 to 850. The FHA allows scores down to 500 with a 10 percent down payment, and 580 with a 3.5 percent down payment. Many lenders refuse to finance borrowers with low credit scores, however.

Interest Rate Difference

Borrowers with scores in the FHA lender's bottom tier pay the highest interest rates. The difference in rates usually ranges from about 0.5 percent to 0.25 percent among the various credit tiers. For example, if you have a 620 to 639 score, you might expect an interest rate that is at least 0.5 percent higher than a borrower with a 640 to 659 credit score. Scores in the highest credit tier of 760 to 850 result in the lowest interest rates. Excellent credit might yield interest rates about 1.5 percent lower than average credit. The difference in rates tends to be more dramatic among the lower credit tiers and decreases when scores reach 680 and above, which is considered "good" to "excellent" credit.

Risk-Based Adjustments

Lenders price your loan or determine your final interest rate by calculating the total of your risk-based adjustments. These adjustments may add or subtract "points" -- which equal 1 percent each -- from your interest rate. Their sum ultimately determines your loan's final rate. Credit score is one type of risk-based adjustment, and it may add several points to the rate if you have average credit. You can offset or reduce this increase, or rate "hit," with positive adjustments, such as choosing the lender's FHA loan program with the best interest rates at the time. Often, the 30-year fixed-rate loan for purchases offers the lowest interest rate of all FHA loans and comes with a lender credit -- points that may be used to offset rate hits.

Credit Change Effects

Your score may fluctuate during the FHA loan approval process. If you take out another loan or increase balances on your credit cards, your credit score may drop and result in a rate increase. When your credit is borderline, you may experience a rate increase if you no longer fall within the higher credit tier, or you may even lose your FHA loan approval altogether.

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