Angela K. Love
Personal + Business Finance Consultant

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The Credit Score Fight

A Wall Street Journal article, A Fight Over the Credit Score Lenders Use for Your Mortgage, by AnnaMaria Andriotis, discussed how non-bank mortgage lenders want to use credit scoring by VantageScore.  A similar article, This battle over credit scores could shake up the mortgage market, can be found on The Real Deal. 

Currently, Fannie Mae and Freddie Mac loans require the use of the FICO score.  Many financial institutions complete mortgages and then sell the mortgage to Fannie Mae and Freddie Mac (Fannie and Freddie).  If a borrower does not meet the FICO score requirement, and the lender is using the Fannie and Freddie product, they are turned down for the loan.  Fannie and Freddie do not allow for any other scoring system to be used. 

Lenders can use mortgage products other than Fannie and Freddie.  Some lenders will keep some mortgages in-house and service the loan themselves.  Or, they may bundle a group of mortgage loans and sell them to another company.  For example, when my spouse and I obtain our mortgage, it was sold to another financial institution.  The financial entity where we made our mortgage payment changed to the company where our mortgage loan was sold. 

Many non-bank mortgage lenders think the FICO scoring system is too restrictive, especially for borrowers with no credit history or younger folks who have not had enough time to create a credit history.  Additionally, Fannie and Freddie require a borrower to have a certain number of unsecured and secured credit lines which use to be two of each.  Two lines of both secured and unsecured credit for six to 24 months can be difficult for a young twenty-something to obtain.  For the person who has avoided credit, it is impossible to meet the requirement, and most borrowers are unaware of the credit requirements for a Fannie and Freddie mortgage.  These are the issues stated by non-bank lenders. 

Non-bank lenders want Fannie and Freddie, which is managed by the Federal Housing Finance Agency (FHFA) to allow for a new and different scoring system, VantageScore.  VantageScore is a collaboration of the three credit bureau agencies, Equifax, TransUnion, and Experian.  The two articles stated VantageScore could give a score to 30 million people who do not currently have a FICO score.  Of those 30 million, 7 million would qualify for a loan. 

Opponents to VantageScore state it is not as restrictive as it should be, which could be accurate since proponents of it state more people would qualify for loans who don’t currently qualify for mortgages.  The problem for lenders giving loans to those without a credit history is, in fact, the lack of a credit history.  65% of the FICO deals with the issue of a borrower’s credit character.  A borrower with little to no credit history is viewed as a higher risk because their credit character is unknown.  Character is one of the Five C’s of credit, and many creditors determine a borrower’s credit character based on their willingness to pay back their loan.  The FICO score mix allocates 35% of the score to payment history, making it a big deal.  30% of the FICO score is allocated to how much a borrower owes and how much credit is available to them. 

The bottom line for borrowers is making sure a new loan makes sense.  A loan should not be accepted just because a person qualifies.  People are approved for loans based on numbers that do not include living, medical, school, and other expenses.  Many times, the debt number ratios used by a lender look great, but once the mortgage loan is approved, the borrower struggles to make the payment.  This phenomenon is known as being house poor.  Why does this occur?  It is because the lender did not include expenses beyond monthly debt payments.  Monthly expenses outside of debt payments are different for everyone due to financial behavior, making it impossible for a lender to allocate for them when determining debt ratios. 

A borrower can avoid potential financial struggles resulting from too much debt by calculating their numbers based on their financial behavior.  Borrowers should determine how a new monthly mortgage will affect their budget, being mindful to subtract the current rent/mortgage payment the new mortgage will omit. 

Not sure if a new mortgage is the way to go?  Try before you buy!  Determine the dollar amount of the new monthly mortgage payment.  Remember to include taxes and insurance into the payment amount.  Also, if you will be putting down less than 20% toward the mortgage, you will need to include a monthly private mortgage insurance (PMI) payment into your calculation.  There is no way around PMI if your down payment is less than 20%. 

Once you determine the potential new mortgage payment, calculate the difference between it and the rent or mortgage payment the new mortgage will replace.  For example, if your current monthly rent payment is $500 and the new mortgage payment will be $800, the difference is $300.  Once you calculate the difference, put that amount into your savings account every month and see how it goes.  Is it workable?  Do you have to drastically change spending habits to make it work?  If so, can you do that for the life of the new mortgage loan which is 15 to 30 years depending on the loan term you choose? 

If you try before you buy for three to six months (I recommend the six-month option) and it goes smoothly, you know you are ready.  If the journey was rough, you should wait.  Trying it out first avoids new or additional financial stress if the new potential loan amount is too much.  It is okay to wait until it works!  And, if you need to wait, hopefully, you have additional money in your savings account from trying.