Lenders use three criteria to decide whether or not to approve a mortgage application. Borrowers must meet minimum standards for credit scores, loan-to-value ratios (LTVs) and debt-to-income ratios (DTIs) in order to be approved. Minimum standards vary by the type of mortgage in which you are applying for and by the lender.
Over the past three years, mortgage lenders have been slowly loosening their standards for mortgages. Understanding the reasons for this trend and the differences among different loan types will help today’s borrowers understand their options.
Credit scores, LTVs, and DTIs
The most widely discussed lending standards are FICO scores, the credit scores created by Fair Isaac Corporation. FICO scores are based on information from consumer credit reports maintained by the three leading credit reporting bureaus, TransUnion, Experian, and Equifax. All three bureaus grade your credit history on a range from 350-850. Your score will be different from each credit bureau because not all creditors report to all three companies.
Debt-to-income ratios measure the cost of servicing a borrower’s debt on a monthly basis compared to the borrower’s pre-tax monthly income. A DTI of 30 percent means that the borrower is paying 30 percent of his gross monthly income to pay the monthly cost of existing debt. DTI is expressed two ways. “Front-end” DTI represents the ratio of debt to income at the time the borrower applies. “Back-end” DTI is the ratio after the monthly cost of the mortgage is added to existing debt.
Loan-to-value ratios measure the borrower’s exposure in each transaction. A loan-to-value ratio of 90 percent means the borrower is putting 10 percent down and the lender is responsible for the remaining balance. The higher the LTV, the greater the exposure for the lender.
Trends in mortgage approvals
Following the housing crash of 2008, lenders immediately raised their lending standards to stabilize housing markets and restore faith in the nation’s system of housing finance. Tougher standards were a reaction to the lax standards and enforcement that prevailed during the boom years that preceded the crash and over the past decade, they have loosened slowly.
Since 2015, average FICO scores for all mortgages have fallen from an average of 731 to 721. Averages of FHA purchase mortgages (loans to buy rather than refinance a home) are down about 10 points to an average of 677. At an average of 751, conventional purchase mortgages are virtually unchanged.
Any borrower who is concerned with getting approved should consider an FHA loan. FHA is best known among first-time buyers for its 3.5 percent down payment, but its FICO scores are 70 points lower than conventional mortgages. If your FICO is lower than 580 but higher than 500, you can still get an FHA loan, but you have to put down 10 percent. One of FHA’s drawbacks is its requirement that borrowers take out FHA mortgage insurance. Unlike private mortgage insurance, FHA insurance cannot be canceled when the owner has achieved 80 percent equity. It continues until the house is sold or the owner refinances.
Conventional lenders underwrite FHA loans, which are backed by a 90 percent government guarantee, reducing the risk for lenders substantially. FHA loans also can handle borrowers with higher levels of debt. Average DTIs for FHA purchase loans in March 2018 were 29/44 (29 percent front-end and 44 percent back-end) compared to 24/46 for conventional purchase mortgages.
The table below shows average and minimum/maximum lending standards for FHA, conventional and VA home loans.
Average Mortgage Lending Standards as of March 2018