You Don’t Need A 720 Credit Score To Qualify
Credit score requirements have come a long way since the housing downturn a few years ago.
Lenders imposed “stealth” credit score requirements on applicants. Their minimum scores were much higher than the stated guidelines from the agencies that backed the loans: Fannie Mae, Freddie Mac, the Federal Housing Administration (FHA), and others.
For example, FHA loan guidelines states an applicant needs a 580 score. Fannie Mae stated a minimum of 620. Yet in 2012, the actual FICO for approved mortgages was 746, and the score for denied loans was 701.
Fewer than half of loans applied for actually closed back then.
Today things have turned around. Many lenders are approving FHA loans down to a 580 score. And according to loan software company Ellie Mae, 7 in 10 mortgages reach the closing table, a new high since the company started tracking data.
In 2016, a lower credit score doesn’t have to be the end of your homeownership goals.
FHA Credit Score Minimums Are Falling
Stricter-than-book guidelines are called lender “overlays.” Lenders use them to reduce the chance of loans going into default and costing them money.
Lenders want to keep default rates low for a couple of reasons.
The first is that when lenders sell loans to investors, they can be forced to buy back bad loans if any errors were made during the underwriting process. Mistakes do happen, so lenders use tougher guidelines to reduce defaults that could cost them.
The second reason is that lenders could lose the ability to sell government-backed FHA loans if their default rate is higher-than-average for their area.
That applies even if they make no underwriting errors.
This measurement is called a “compare ratio.” Lenders made their internal requirements harder so that their default rate would be lower than average for their area
That forced nearby lenders to do the same.
No one wanted to be the “worst bank on the block” in the eyes of FHA.
Fortunately, the rules are starting to change. FHA has implemented changes that allow lenders to drop FHA credit score minimums and allow more applicants to qualify.
Lenders Peel Back Overlays
A lot has changed in four years.
For one thing, demand for refinancing dropped, so lenders had to ease up to keep applicants coming in the door.
Today, the majority of mortgage applicants are successful, according to Ellie Mae, with more than 70 percent of applications resulting in closed loans as of May 2016.
The same month, the average FICO for successful applicants was 724, and nearly one in four approved FHA applicants had FICOs between 550 and 650.
During the worst of the mortgage crisis, experts estimated that 90 to 95 percent of lenders imposed overlays. By July 2015, Fannie Mae’s Mortgage Lender Sentiment Survey concluded that only 40 percent of lenders were still applying credit overlays.
The government made some changes, too. In 2015, HUD announced changes to the compare ratio system used to evaluate lenders.
The agency created a “supplemental performance metric” to make it easier for lenders to approve loans according to FHA guidelines and make credit available to more homebuyers.
All these changes mean it’s now easier for lower-credit borrowers to buy a home, or finally qualify for a refinance.
Debt-To-Income Ratio: Important For Approval
In 2016, it’s income that matters. New laws were passed that prevent lenders from approving mortgages for borrowers who can’t afford them.
This means lenders have to verify income, analyze debts and determine that the applicants’ debt-to-income (DTI) ratios are reasonable.
Approving mortgages with DTIs at 43 percent or less (debt payments at or below 43 percent of gross income) is the easiest way for lenders to comply with the rule.
However, lenders can approve borrowers with higher DTIs if they can justify it. You just have to look harder to find them.
According to data analysts at Ellie Mae, the average DTI for approved (closed) loans in 2015 was 38 percent, while the average DTI for denied loans was 47 percent. If income is a potential problem for you, that may affect your choice of mortgage. Here’s how the average DTI for approved loans breaks down:
- FHA: 41 percent
- VA: 40 percent
- Conventional: 34 percent
And here is the breakdown for denied loans:
- FHA: 48 percent
- VA: 47 percent
- Conventional: 44 percent
In 2016, if you’re concerned about mortgage approval, you can kill two birds with one stone by paying down consumer debt. Reducing your debt raises your credit score and lowers your DTI, making you a more attractive borrower to any lender.
What Are Today’s Rates?
Mortgages can be had on the cheap, thanks to ultra-low rates. Even applicants with sub-640 credit scores qualify for very low rates.