Mortgages are About to Get a Little Easier
A change in FICO score reporting and loosening of lender qualifying standards are about to open for many hopeful home buyers.
It’s no secret that a low credit score can keep a would-be borrower from qualifying for a home loan. Lenders look first to that critical three-digit number to decide whether to approve a loan for an applicant. If it falls below a certain threshold, they’ll deny the application.
Although many still believe that banks are approving loans only for the highest-score borrowers. Mortgage standards are quite lenient: a borrower with a 620 score is still eligible for a conventional loan. For government-insured FHA loans, 580 is the minimum to get the maximum loan of 96.5%.
The FICO score was developed by Fair, Isaacs, and Company in 1989. As a way for lenders to analyze the risk presented by prospective borrowers. The mathematical model, which is proprietary, considers factors such as:
- credit card balances
- number and age of accounts
- and derogatory entries
Among the “derogs” may be a history of late payments, collection accounts and public record items, such as civil judgments and tax liens.
A borrower scoring at the lower end of the FICO range will typically have some combination of these negative items on their credit report. But for many borrowers, a change in the FICO calculation is giving them a welcome increase in their score.
Starting on July 1, 2017, FICO will no longer consider recorded tax liens or civil judgments when it comes up with that all-important three-digit number. This means that a borrower who lost a Small Claims Court action, or who has one or more tax liens on his report may see a higher credit score soon. Someone who has been struggling to get their scores into the qualifying range for a conventional loan (620 or higher) may suddenly discover that they can now qualify.
This good news does not come without some qualifiers, however. Just because the credit score is higher does not mean that the lender will disregard certain negative items on an applicant’s credit report. Tax liens and judgments will still show up and will have to be dealt with, but now they won’t lower the credit score.
Lenders use the credit score for more than deciding whether to approve a loan. They also set the borrower’s rate based on a combination of the credit score and loan-to-value ratio, or LTV. This is called, “risk-based pricing” in financial lingo. A borrower with a 620 score will pay about .75% more in rate for an 80% loan than a similar borrower with a 740 score. To put this into perspective, the lower-scored borrower would pay about 8% more per month than his 740 counterparts.
There will be benefits for some borrowers in the middle of the credit range, as well: a 20-point improvement, from 660 to 680, could improve a borrower’s interest rate by .25%.
The mortgage door is about to be opened a bit wider on July 29, as well. When mortgage giant Fannie Mae rolls out its latest version of Desktop Underwriter (DU), it’s automated loan approval software.
Lenders calculate a value called the “debt-to-income ratio” (DTI) when evaluating a prospective borrower. They arrive at this number by adding the total house payment (including principal, interest, taxes, insurance, and mortgage insurance, if any) and all debt payments with 10 months or more remaining. They divide that total by the borrower’s gross monthly income to arrive at the DTI. A buyer with $6,000 in monthly income, a $2,000 house payment and a $400 car payment would have a DTI of 40% (2,400 / 6,000 = 40%).
Fannie Mae’s system will approve a loan at a DTI no higher than 45%. After July 29, however, a borrower will see his purchasing power increase by nearly 15% because Fannie Mae has decided to purchase loans with a higher DTI—50%.
This is not to suggest that every home buyer should plan on spending half their monthly income on their house payment. Each consumer should set their budget personally. A lender may allow a house payment of $2,600, but common sense may suggest that a lower number than the lender’s maximum is more appropriate for one’s personal comfort and peace of mind.
Still, the changes are welcome news for many borrowers whose dreams of homeownership just moved a little closer.