Home buyers no longer need perfect credit to score a loan
To get a mortgage lately, home buyers have had to jump through hoops, performing back flips and other acrobatics while lenders grade their credit worthiness with the eye for perfection of an Olympic judge. But they can finally breathe a little easier, data shows. Banks are increasingly willing to overlook credit scores that aren’t quite gold medal material.
The average credit score among borrowers who received a mortgage in September was 732, down from a peak of 750 a year prior, according to new data released today by Ellie Mae, which provides mortgage lenders with loan origination systems. That’s also the lowest average credit score since the company started tracking this data in August 2011. In addition, a greater share of borrowers have lower credit scores. Thirty-two percent of mortgages doled out in September went to borrowers with an average FICO credit score (the measure used by most lenders) of less than 700 compared with 17% a year ago, according to the findings. The changes suggest a critical shift is under way in the housing market, which could help more applicants gain access to home loans. “It does seem there’s a little bit of an opening that’s going on,” says Brad Hunter, chief economist at Metrostudy, a housing-market research and consulting firm. “Lenders are being more lenient.”
Lenders pulled back on giving mortgages to borrowers with less-than-perfect credit in 2008 as the number of borrowers who foreclosed on their homes spiked. That’s left millions of would-be home buyers shut out of the housing market. The findings suggest that some borrowers who were unable to gain financing as recently as a year ago could get mortgage approval now.
To be sure, the bar to getting a mortgage remains high. Applicants who were denied a mortgage in September had an average FICO score of 696, according to Ellie Mae—a score that’s relatively stellar by most counts. FICO scores range from 300 to 850. Before the recession it was common for borrowers with credit scores in the 600 range and below to get mortgages.
Ellie Mae’s data comes from lenders that input mortgage applicants’ information in its software, which processes applications. The data represents 20% to 30% of all mortgage applications in the country.
The recent loosening of credit standards comes as lenders are trying to boost demand for mortgages. Until recently, large numbers of homeowners were refinancing to lower their mortgage rates — a trend that slowed down as mortgage rates started rising earlier this year. Since May, applications for refinancing have dropped 70%, according to the Mortgage Bankers Association. In turn, some lenders “are willing to loosen somewhat to try to increase their purchase volume,” says Mike Fratantoni, vice president of research and economics at the Mortgage Bankers Association. The pace at which borrowers’ average credit score dropped intensified starting in May. Since then, it has declined 11 points compared with a six-point drop from January through May, according to Ellie Mae.
On another level, willingness to accept lower credit scores underscores a delicate balance of give and take that lenders employ. When one risk factor is eliminated (or significantly declines), some lenders are willing to take on more risk elsewhere. Consider the following: As home values increase, there’s less of a risk that borrowers will end up owing more on their mortgage than their home is worth, and therefore less of a risk of borrowers intentionally walking away from their home. As those risks have lessened, lenders have become more comfortable taking on risk elsewhere—in the form of somewhat lower credit scores, says Fratantoni.
For borrowers, the Ellie Mae data offers some insight into where those with less-than-perfect credit scores can find a mortgage. Home buyers who get mortgages backed by the Federal Housing Administration, which require a small down payment, have lower credit scores—694 on average—than those who get mortgages backed by Fannie Mae or Freddie Mac, whose credit scores average 758, according to Ellie Mae. While FHA mortgages have for years had lower credit score requirements than other home loans, lenders say this requirement has loosened even further in recent months. The U.S. Department of Housing and Urban Development, which includes the FHA and which is closed due to the government shut down, did not immediately respond to a request for comment.
In addition, homeowners who want to refinance encounter lower credit hurdles. Homeowners who refinanced into Fannie Mae or Freddie Mac mortgages in September had an average credit score that was 23 points lower than home buyers who received financing that month. That spread has been growing all year; at the end of the first quarter it was just four points. That’s partly because borrowers who refinance tend to have more equity in their home, which makes them less of a risk to lenders who in turn allow for more flexibility when it comes to credit scores, says Stu Feldstein, president of mortgage-research firm SMR Research.
Despite loosening, borrowers with less than ideal credit scores have to pay more to get a mortgage. That’s either in the form of points—meaning that they’re paying a certain number of percentage points of the total dollar amount of the loan upfront—or a higher interest rate, says Mark Goldman, a senior loan officer at San Diego-based mortgage brokerage C2 Financial Corp. Separately, borrowers who have to sign up for private mortgage insurance (a cost that kicks in if borrowers don’t have enough of a down payment) will end up paying more for this if they have lower credit scores. Consider a $200,000 mortgage for a single-family home purchase in California with a 10% down payment: running the numbers with one large PMI firm, a borrower with a 700 credit score would end up paying 0.62% of the total loan amount each year while the same borrower with a 750 credit score would pay 0.49%, says Goldman.
By AnnaMaria Andriotis