Dalrymple: Is credit score the most important element in getting a loan?
Ask A Banker
I hear that one’s credit score is the most important element in getting a home loan, and that a lot of people are being shut out of the current low mortgage rates because their score is too low. Is that right?
A credit score of 750 or above is kind of the gold standard for the best interest rates and most favorable terms in consumer, and even some business borrowing, especially from banks. For example, a borrower looking for a ninety percent of value, $600,000 home loan might have to show that 750 credit score.
Some mortgage programs are excluded when the score dips below the high 680;s, so it’s true that a high score gets, you might say, more bang for the buck on residential real estate loan.
But that doesn’t mean that borrowers with lower credit scores can’t borrow to buy or refinance a home. For example, FHA insured, and VA guaranteed loans accept borrows with a minimum 620 score. The former program requires minimum down payment of around 3 percent, while VA loans require no money down. And the maximum loan amount for these programs is $417,000, which can accommodate a lot of borrowers.
Some critics say that an over reliance on credit scores excludes qualified borrowers from certain types of credit. Up to a point, that’s probably true. Anytime you impose numerical criteria on the marketing of a commodity to be used by humans, there will be some deserving people that don’t quite fit the mathematical mould.
The credit scoring protocol appeared in the early ‘90s and was refined until, by the turn of the century, it was the major element in granting consumer credit. Before that, credit reports had information as to how a prospective borrower handled existing debt, what matters of public record might pertain to the individual, and collections that may have been filed. But there was not a mathematical qualitative analysis. Assessing a borrower’s credit was essentially subjective.
Subjectivity doesn’t work in putting together securities, backed by loans, to be sold to investors and almost all home loans were thus packaged. A security’s quality needed to be definitively measured to assign risk levels for potential investors. If a security was backed by loans in which the borrowers had, say, an average credit score of 700, the risk was deemed to be less than the paper with an average of 650: thus, a lower yield on the 700 package than on the one with the 650 average scores.
Inevitably, over-reliance on credit scores became the norm in the leading up to the Great Meltdown of 2008. In mortgage loan underwriting, scoring became the major, and eventually, in many cases, the only, factor. At the end of the feeding frenzy, so called NIV (No Income Verification) loans became common, and finally, billions of dollars of No Income, No Asset Verification deals were funded. Loan originators called these mortgages “Stated, Stated”, meaning you could say your income was whatever you wanted it to be, and your assets as well. Aside from being an invitation to fraud (which virtually no one was prosecuted for) it, not surprisingly, turned out to be the road to economic disaster.
The whole mind boggling structure of mortgage backed investment paper was largely built on a little, bitty number: the FICO score. Other underwriting guidelines were ignored. If a borrower made their car payments on time, they likely could qualify for a loan of $100,000, $200,000, or even $300,000 more than they could actually afford.
The Great Recession changed that, and now a borrower’s credit score is just one element in the loan analysis process, along with the sufficiency of income, probability of continued income, and available liquid assets.
But there is a realization that there are very deserving borrowers who may have a low FICO score. For example, a lot of good people lost good jobs in the 2008 crash through no fault of their own. There are now non-institutional (non-bank) lenders that accept numbers below 620. Although their rates are high, and often the loan to value ratios low, these sources can often be a viable alternative for some borrowers.
Finally, the various credit reporting agencies are very willing to work with consumers to help them improve their credit score.
Pat Dalrymple is a former bank president who has been making mortgage loans in western Colorado since 1967. He’s currently an advisor to Grand Mountain Bank’s Mortgage Lending Outreach Initiative. He welcomes your questions on lending and banking, and can be reached at email@example.com.
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