After taking a year to evaluate Fannie Mae’s new program helping first-time homebuyers get a mortgage without a credit score, counterpart Freddie Mac is following with its own program.
As of June 26, Freddie Mac is automating the underwriting process to allow non-traditional sources of credit history such as rent payments and utility bills to be used to establish credit for people who don’t have a FICO credit score.
“We’re committed to supporting responsible lending and improving access to credit for all borrowers, including first-time home buyers, low- and moderate-income buyers and underserved populations,” said David Lowman, executive vice president of Freddie Mac’s Single-Family Business, in a statement. “It’s important that we keep pace with the evolving needs of the U.S. market and help support sustainable homeownership.”
Non-traditional credit could be used previously on an application, but the mortgage had to be manually underwritten — which often made it difficult to be approved, says Matt DeCesaro, southeast regional builder manager at HomeBridge Financial Services in Johns Creek, GA.
“That automated approval is like gold,” DeCesaro says.
Importance of credit
The higher the credit score an applicant has, the more likely they are to be offered better mortgage rates on loans and offered different types of loans.
Lower scores can make it harder to qualify and can lead to a higher interest rate and a larger down payment.
Mortgage lenders can have difficulty assessing the ability to pay by people who don’t have credit scores, since credit scores are considered good predictors of if someone will repay their home loan.
Non-traditional credit building is meant to fill that gap for applicants without credit scores that are normally calculated using payments on credit cards and other types of loans. Non-traditional sources of credit history include:
- Utility bills
- Cell phone bills
- Insurance payments
- Personal loan with written terms and cancelled checks
- Employment history
- Tuition payment
Using these nontraditional credit options will probably help millennials the most, says Freddie Hunyh, vice president of credit risk analytics with Freedom Financial Network, who previously analyzed credit scores for FICO.
“In the wake of the Great Recession, more and more young consumers were eschewing credit cards,” Hunyn says. “In doing so, millennials were engaging in practices that did not allow credit histories to be built.”
How automated underwriting helps
Until these changes were instituted by Fannie Mae and Freddie Mac, a loan application for someone with non-traditional credit was manually underwritten. The loan documentation was verified by hand and not by computer software.
Because that type of preliminary loan approval was done by a human instead of a computer, it was likely to be more strict and led to more rejections, DeCesaro says. Manual underwriting guidelines can also have more requirements, such as a higher down payment or smaller loan amount.
Even with manual underwriting, most banks won’t underwrite a home loan where the applicant doesn’t have traditional credit, DeCesaro says. The change to the Automated Underwriting System, or AUS, will help borrowers without a credit score get the same mortgage interest rate as they would have if they had a credit score, he says.
“Not it’s more in the hands of a computer and less in the hands of a human, so the consumer is getting what they should have gotten before,” he says.
Manual underwriting may still be needed if the AUS generates a “Refer” recommendation, requiring more information before it can make a decision.
Freddie Mac requirements for no-score loan
Borrowers without credit scores must meet these requirements from Freddie Mac for automated underwriting:
- Loan must be for a purchase or “no cash-out refinance.
- A 1-unit property that all borrowers occupy as their primary residence.
- Must be a single-family home and not a manufactured home.
- Fixed-rate mortgage.
- At least a 5 percent down payment.
- At least one borrower must have a housing payment history as a payment reference.
For homebuyers without credit scores, having their loan application underwritten automatically instead of manually should save them time and lead to more approvals. The automated assessments should give borrowers and their lenders more certainty that the loan will be purchased by Freddie Mac.
For someone without a credit card who can afford to buy a home, that’s good news.