Good News for Buyers with Less Than Great Credit
The three greatest barriers keeping renters from becoming homeowners are financial: saving for a down payment, finding an affordable house, and qualifying for a mortgage loan.
The down payment problem is less pressing since nearly 3,000 state and local governments offer low down payments as well as FHA, Fannie Mae and Freddie Mac. Some conventional lenders are offering mortgages with down payments as low as 1 percent for buyers with good credit. Hopefully, the supply of affordable homes for sale will improve this year as more new homes are built and the improving economy helps move-up buyers buy larger homes and put their old ones up for sale.
Getting approved for a mortgage is a problem that is not so easily solved. Paying off debt and improving one’s credit score takes time and discipline. Even those with a bad record who manage to get a better score may not succeed. In getting a mortgage, many lenders today use “trended data,” which identifies credit behavior over time and rewards those who maintain good credit, not those who try to fix up their credit quickly to erase years of bad behavior.
Today, buyers who failed in the past to get a mortgage have new opportunities to get the financing they need.
Looser lending standards
Many of the six million homeowners who defaulted on their mortgages when home values creased ten years ago couldn’t get a mortgage today. After the crash, lenders quickly raised their underwriting standards. The days of the “pulse loan” were over (if you had a pulse, you could get a loan.) A higher bar for credit scores and debt kept out young buyers with short credit histories.
Some lending standards are loosening very gradually. An analysis (below) of standards in December 2012 and December 2017 show that most of the decline in standards has occurred in FHA loans rather than conventional loans. The average FICO for an FHA loan has fallen 20 points and 10 points for conventional loans. The average percentage of debt-to-income before the cost of a mortgage rose from 27/41 in 2012 to 29/48 in 2017 for FHA loans, and the closing rate for all loans rose from 61.3 percent to 72.1 percent in 2017, reflecting the weeding out of potential buyers with lower credit who didn’t bother to apply and the loosening of standards.
|Average Credit Score
In 2018, the loosening of standards may accelerate. A fourth quarter 2017 survey by the Federal Reserve found that more banks are easing standards on GSE-eligible and nonconforming jumbo residential mortgage loans.
Another change that occurred as a result of the housing crash was the disappearance of higher risk sub-prime loans. However, another kind of loan is filling the gap it left. Non-QM loans are more closely regulated and only lenders who market the higher risk loans to investors are entering the field.
QM, or qualified mortgage loans are a new class of mortgages designed to add a level of protection to lenders and investors. They quickly became the industry standard because QM loans reduce lenders’ liability and can be automatically underwritten which are easier to sell to Fannie Mae and Freddie. Non-QM loans do not comply with the new standards.
Recently, S&P Global Ratings predicted the market for non-QM loans would double or triple in 2018 because of the pent-up demand from borrowers who have been passed over for traditional loans.
“We estimate that about 100 million people have FICO scores lower than 650. One of the things we found working with this underserved segment of the market is that over 73 percent of them are first-time home buyers,” said Ray Brousseau president of Carrington Mortgage Services, a recent entrant into the non-QM loan business. “Introducing these products is the next evolutionary step in our ongoing commitment to serving underserved borrowers across the country.”
As more lenders enter the field, potential buyers who have been turned down for a mortgage will have another option for homebuying.