Do you have a low credit score? You may be in for a little luck if you want to buy a home.
It’s easier to buy a house now than it was a decade ago. More homebuyers are qualifying for a mortgage with a low credit score than they did just after the Great Recession, partly because of more lax Federal Housing Administration loans. Higher debt is also being allowed more often by home lenders.
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 mortgage 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. New mortgages with FICO scores less than 750 increased from 41 percent to 53 percent during the same time.
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 FHA 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.
Why the shift?
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.
Credit behaviors of mortgage borrowers
In its mortgage originations report, FICO looked at what mortgage borrowers did to change their credit score, whether for good or bad.
Of about 2.8 million people who opened mortgages between May and July 2017, 12 percent had a significant increase of 40 points or more to their credit score. Another 11 percent saw their score drop the same amount and the remaining 77 percent had a relatively stable score change of less than 40 points.
Its analysis found that people who raised their credit score mostly did it by reducing credit card balances by almost half. Those who saw their score drop added to their credit card balances by 97percent, or almost doubling their credit card debt.
Consumers with a decrease in their credit score were much more likely to have had a missed payment in the past year. Payment history accounts for 35 percent of total score calculation.
Credit score decreases also resulted from applying for new credit, with credit inquiries increasing 22 percent for those with a FICO score decrease. People with a credit score increase had their credit inquiries drop by 21 percent.
Opening several accounts in a short period of time is a greater risk of future missed payments, especially for people who don’t have a long credit history, according to FICO. New credit makes up about 10 percent of a FICO score.