If you have a low credit score and want to buy a home, your odds of getting a loan have improved. A study by the Fair Isaac Corporation (FICO) shows that credit scores for new mortgage originations have been dropping, suggesting that lenders are slowly relaxing the tight credit policies imposed after the housing crisis.
According to the study, new mortgage loans with credit scores less than 700 increased from 21.9% of all mortgage loans in 2009 to 29.7% in 2017. These include scores in the subprime market that can reach down into the 400s. (While the typical lower credit score limit is 620 for conforming loans and 500 for FHA loans, loans may be granted at even lower credit scores with extenuating circumstances.)
The shift in average credit scores is driven by FHA loans – as expected by the lower acceptance criteria for FHA loans. The latest Origination Insight Report from Ellie Mae shows that only 16.7% of conventional mortgage loan originations in July 2018 were associated with FICO scores less than 700.For FHA loans, over 65% of FHA loans went to borrowers with scores below 700.
Between January and March of this year, the average credit score for a new FHA loan was 672, compared to 701 between January and March of 2011. For refinances, the average score fell from 709 in mid-2012 to 661 in early 2018.
People are also going further into debt to make these home purchases. Debt-to-income (DTI) ratios – one of the primary methods of assessing a borrower's ability to repay – have been rising for FHA loans. In 2013, only 12.7% of new FHA mortgage loans had DTI ratios above 50%. In the first quarter of 2018, that percentage had doubled. Another 30% had DTI ratios between 43% and 50%.
Fair housing advocates have complained that tight credit has been stifling home ownership for years. The Housing Finance Policy Center from the Urban Institute estimated that tight credit prevented 5.2 million American households from becoming homeowners during the post-housing-crisis years of 2009-2014. However, it's fair to question the line between restrictive lending practices and enabling homeowners who really can't afford to buy a home.
Consider that a DTI ratio of 50% means that half of your income goes to all of your collective monthly debts –including credit card debts, other installment loans, and certain monthly obligations like alimony and child support. With a high DTI, you have little room for any other financial hardships and have a greater risk of missing payments and defaulting.
Should you join the crowd taking advantage of looser credit? Honestly assess your financial situation – not just presently, but for the foreseeable future. Is there good reason to expect your income to increase significantly in the future? What other obligations are in your future, like child-raising expenses and college funds?
If you plan to apply for an FHA loan, review your long-term budget and set realistic housing goals. If necessary, seek financial advice from a qualified financial professional. An outside source can provide an objective view of your likelihood of handling the collective payments.
While you may now have the opportunity to buy a home even with low credit, it may not be the smartest move. Can you really afford to devote over 50% of your income to your mortgage and credit obligations? If you're that close to the financial edge, consider buying a less expensive home – or wait and work on saving more money for a future home purchase.
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