If you're in the market for a home, a high credit score is key to qualifying for a mortgage loan and getting the lowest interest rates possible. What do you do if your credit score is toward the lower edge of qualification?
The March 2019 Chartbook from the Urban Institute's Housing Finance Policy Center has good news for you. Median FICO credit score limits dropped from 730 to 727 from November 2018 to February 2019 – not much of a change, but every point matters when you're near the edge.
The housing crisis drove qualifying FICO credit scores for mortgages up significantly. Median scores for mortgages rose from 700 pre-crisis to 733 in 2013, but at the 10th percentile – generally the lowest acceptable credit score to qualify for a mortgage – borrower scores rose from less than 600 to just over 650 in 2013. As of February 2019, the 10th percentile borrower credit score was at 642, well above pre-crisis levels.
Potential homebuyers with lower credit scores are usually better off seeking loans from non-bank lenders, and non-bank lenders are driving the downward trend in acceptable mortgage loan credit scores. Over the last four years prior to February 2019, the median FICO required by banks stayed relatively constant between 745 and 755 while the median borrower FICO score for non-banks slowly decreased from around 730 to 713.
Why is the gap increasing? Banks are increasingly moving away from FHA loans. FHA mortgages target higher-risk homebuyers with lower credit scores and lower down payments. Credit scores for FHA loans can drop as low as 500 with a 10% down payment, or as low as 580 with a 3.5% down payment.
FHA-approved lenders range from large banks to small credit unions and independent lenders. However, non-bank sources are more likely to tolerate higher debt-to-income ratios, lower credit scores, and lower down payments that are often rejected by the automated underwriting systems of larger lenders. Larger banks are less willing to accommodate the risk.
A shrinking refinancing market may be partly to blame for the credit score threshold decrease. Since interest rates are rising after years of historically low interest rates, most homeowners who qualify for refinancing have already taken advantage. To keep overall mortgage origination volumes high, lenders must compete for new mortgage loans – raising the pressure to accept riskier loans.
The Urban Institute's Chartbook expects these trends to continue. Refinance shares are expected to decrease from 38% in Q1 2019 to 27% in Q4 2019, and then average 26% in 2020. Pressure should remain on mortgage lenders to continue loosening credit.
That's good news for you – but only if you can take advantage. Lower standards are not the same as no standards.
Before you start your home search, check your credit report for any signs of fraud or identity theft that could harm your credit score. You can check your credit score and read your credit report for free within minutes by joining MoneyTips. Address any problems with your credit report immediately – and if your credit score still needs work to qualify for a loan, lay out an improvement plan. Your plan must include a realistic budget that controls spending before and after your home purchase.
Assess your finances and housing needs honestly. How much home can you afford to buy? Does a home that you can afford meet your needs? If not, it's back to the budget for another round of cuts.
Finally, compare lenders for the best interest rates. You may find a better option with a non-bank lender. Their greater risk tolerance may be just what you need to make your dream home a reality.
MoneyTips is happy to help you get free mortgage and refinance quotes from top lenders.