May 19, 2014
Mortgage lenders are lowering mortgage credit standards nationwide.
Effective immediately, home buyers and refinancing households can get approved for an FHA loan or a conventional loan with lower credit scores than during any time in the last five years.
Combined with mortgage rates today, which are at an 11-month low, it’s an excellent time to apply for mortgage.
Mortgage Credit Score Minimums Drop
It’s getting easier for borrowers to get approved for a mortgage. As the economy has improved, jobs growth has been ongoing; home values have climbed steadily; and the number of loans in default have dropped dramatically.
Lenders are taking fewer losses and realizing bigger returns. In response, they’re loosening loan guidelines in an effort to reach consumers who have been thus far locked out from the housing market rebound.
Earlier this year, U.S. lenders lowered minimum credit score requirements by 40 points for borrowers using FHA-backed financing, opening the low-downpayment program to a wide swath of underserved borrowers.
Lenders are making a similar move for conventional loans.
Lowering credit standards is a big deal in the U.S. housing market. Credit scores predict the probability of foreclosure with lower credit score correlating to high foreclosure probability.
During last decade’s housing market downturn, homes in foreclosure cost banks hundreds of millions of dollars. As more loans went bad, banks grew more risk-averse, tightening up what they would lend, and to whom.
This month’s loosening of loan standards suggests that fewer loans are defaulting nationwide, and that banks are willing to assume new risk given today’s strengthening economy.
For today’s buyers of homes and households wanting to refinance, this is good news.
You no longer need “perfect” credit to get access to Fannie Mae- and Freddie Mac-backed mortgages. A 620 FICO score now works just fine.
The Mortgage Approval “Triangle”
Because there are tens of available mortgage programs, there is no “one” formula for getting approved for a mortgage. However, mortgage approvals almost always focus on three key areas — your income, your equity, and your credit.
In this three-pronged approach, “income” is the amount of documented income you earn annually as compared to your monthly debts. In general, your debts must not exceed 45% of your documented income.
This ratio is known as your debt-to-income (DTI) ratio.
“Equity” is the amount of equity, in percentage terms, you hold in the home you’re mortgaging. For a home buyer, your equity is equal to your downpayment. For a refinancing mortgage applicant, your equity is your loan size divided by the home’s value, a ratio known as Loan-to-Value (LTV).
Loan-to-value requirements vary by program. For example, for borrowers with a FHA-backed loan, the maximum LTV on a home purchase transaction is 96.5%. On an FHA refinance, however, there are no LTV restrictions at all.
Or, for a military borrower using a VA loan for a purchase, the maximum LTV is 100%; there is no downpayment required whatsoever.
The third prong in mortgage underwriting is “credit”.
Your credit score is a based on a formula which determine the likelihood that you’ll go 90 days without making payment to your lender, which puts your loan into default. Credit scores are on a scale of 300-850 and are sometimes referred to as “FICO” scores, generically.
Credit scores of 740 or higher are considered excellent.
To get a mortgage approval, it’s not required for applicants be “excellent” in all three prongs of the mortgage approval triangle — you must only earn a “passing” grade.
With credit standards dropping, it’s easier for today’s borrowers to get approved.
Loan Programs For Borrowers With Average Credit Score
Mortgage lenders are loosening home loan standards. They’re lowering minimum credit score standards and granting more “exceptions” as compared to last decade.
If you were recently turned down for a mortgage because your credit score or income, it might make sense to re-apply — especially because of the number of home loans now available to borrowers with less-than-perfect credit scores.
One such program is the USDA Rural Housing Loan, which allows 100% financing for home buyers in rural and suburban neighborhoods. The USDA loan backed by the federal government, is available in all 50 states, and requires a minimum FICO score of 620.
Another available program is the VA loan, which also enforces a minimum FICO score of 620. VA loans are available to members of the military and require no downpayment whatsoever.
VA loans require no mortgage insurance and can be assumed by the future buyer of your home. This means that your 3.75% mortgage rate can be “sold” along with your home, so long as the buyer can be VA loan-approved.
Assumable loans add value to a home in a rising mortgage rate environment.
A third program for borrowers with less-than-perfect credit scores is the FHA home loan. Official FHA guidelines state that a 500 FICO score is required to get approved, but many lenders will underwrite to a minimum 580 FICO or better.
FHA loans are assumable, as well.
Low-credit-score borrowers can also use conventional mortgage financing. Conventional loans are loans which are backed by Fannie Mae or Freddie Mac.
Conventional loans are available with credit scores of 620 or higher, and can be the best choice for buyers with downpayments of 10% or more; or for refinancing homeowners with home equity of at least twenty percent.
Additionally, Fannie Mae or Freddie Mac can access the Home Affordable Refinance Program (HARP) program. Sometimes called the “Obama Refi”, HARP loans are for homeowners whose homes have lost equity since the date of purchase.
HARP is allowed with a 620 FICO score or better.
Get Today’s Live Mortgage Rates
As mortgage rates move to an 11-month low, mortgage lenders have opened their loan guidelines to a wider group of applicants. If you’ve been turned down for a mortgage in the recent past, consider applying again.