If you have a low credit score and high debt, buying a home is easier than it was almost a decade ago.
A study by the Fair Isaac Corporation, or FICO, which is the most widely used type of credit score among lenders, found that credit scores for new mortgage originations have been dropping since tighter credit policies were enacted after the housing crisis.
That sounds like an oxymoron — lower credit scores allowed by mortgage lenders who tightened underwriting standards — but the looser requirements are mainly allowed by FHA loans that are among the easiest to get for people with low credit.
New mortgage loans with credit scores less than 700 increased from 21.9 percent of all mortgages in 2009 to 29.7 percent in 2017. These include subprime loans for borrowers with scores in the 400s.
FICO scores range from 300 — which shows severe credit history problems and a high risk of default — to a high of 850 — where missed payments and default risks are extremely low. The higher a credit score is, the better chance the loan applicant has of being approved at a low interest rate.
Loan originations for FICO scores of less than 650, which are considered mediocre or bad scores, increased from 9.1 percent in 2009 to 10.9 percent in 2017.
More debt, too
Bigger debt-to-income ratios, or DTI, have also been allowed in FHA loans, according to Federal Housing Administration data. DTI measures a home buyer’s ability to repay their loan. Household income is weighed against ongoing monthly debt such as credit cards, auto loans, personal loans and other obligations, plus mortgage payments. The higher the monthly debts, the more likely a borrower is to go delinquent on their new mortgage.
Spending half of your income on debt was often seen as a bad sign to lenders. FHA loans, however, allow it, with one of every four FHA loans between January and March 2018 having a DTI ratio of more than 50 percent. In 2013, it was about half that, with 12.7 percent of approved new FHA applications carrying such a high debt load. Another 30 percent had DTI ratios between 43 and 50 percent.
A more lenient DTI has been allowed by more lenders in the years after the recession in part because they realized it was too tight, says David Krichmar, a mortgage banker at Legend Lending Corp. in Houston.
“I think they overcompensated when the market crashed and became extremely conservative,” Krichmar says. Some of those risks, such as interest-only loans, are coming back.
While DTI standards have loosened, lenders “didn’t jump off the deep end,” he says. Even for people with credit issues, income verification and other steps that may not have been taken during the housing crisis are back, he says.
“Subprime loans went away, making it perceived that some people couldn’t afford a home, scaring some people away,” Krichmar says.
Why the shift?
There’s a fine line between restrictive lending practices and enabling homeowners who can’t afford a home. But the Urban Institute’s Housing Finance Policy Center has found that 5.2 million mortgages were “missing” between 2009 and 2014, meaning they would have been made if lenders had relaxed their strict underwriting standards after the recession.
FICO gave a few reasons for the drop in credit scores among new mortgages, starting with the fact that there are fewer refinances occurring now.
“Many high scoring consumers took advantage of the historically low mortgage rates observed in 2012-13 to refinance their mortgages,” FICO officials wrote. “Once the refinance boom ended in 2014, the volume shifted back to purchase mortgages, which tend to be a lower scoring population than the mortgage-experienced segment.”
Conventional mortgages still require a good credit score, with 41 percent of such home loans closing in August 2018 for borrowers with a credit score of 750-799, according to data from Ellie Mae, which processes 35 percent of U.S. mortgage applications.
FHA loans, however, are another story. Home loans insured by the FHA saw credit scores drop, from an average of 701 from January through March 2011 to 672 for the same period this year, according to FHA data.
FHA loans are typically the easiest types of mortgages to qualify for because they require a low down payment and credit scores as low as 500 are allowed
Some home loan programs backed by Fannie Mae and Freddie Mac, which were bailed out by the federal government 10 years ago, also allow low credit scores — the Home Ready and Home Possible programs. They have higher loan level price adjustments to the mortgage rate paid by borrowers with smaller down payments — from 0.25 to .50 percent higher, depending on the down payment, Krichmar says, but that still doesn’t amount in much of a higher monthly mortgage.
For a $300,000 home with a 3 percent down payment, adding .375 percent to the interest rate on a 30-year fixed-rate loan would only add $70 per month to the mortgage, he says.
Krichmar says that 40 percent of his clients have credit scores lower than 680, which is an average score. That more than qualifies them for a Fannie Mae-backed loan, which requires a minimum 620 score, he says. For FHA loans he says he can find loans for borrowers with scores as low as 580.
Allowing lower credit scores and higher debt have made homes easier to buy for some people, which is better than waiting a year or more to improve your credit and spending that year watching home prices rise, Krihmar says.
“Most people are not waiting to buy because they know home prices are going to increase and interest rates are going to increase,” he says.