According to a recent report by The Urban Institute, mortgage credit is coming into reach for a growing number of Americans. The median credit score associated with home mortgages backed by primary mortgage purchasers Fannie Mae and Freddie Mac dropped from 742 to 725 between June 2016 and April 2017, resulting in the lowest median value since the housing crisis.
At the same time, Fannie and Freddie are altering one of the primary criteria for potential mortgage borrowers. Both agencies are increasing the acceptable limit on debt-to-income ratio (DTI), the percentage of your gross income devoted to paying off your monthly debts, from 45% to 50%. In essence, lenders are willing to cut you more slack on your debt load when evaluating your ability to repay a mortgage.
On the surface, this is good news for the housing market. A lower median credit score and greater debt tolerance opens up the housing market to more potential homebuyers, helping to spur market growth. However, each factor has secondary considerations that may blunt the positive effects.
Supply and Demand
The Urban Institute's more detailed analysis found that mortgage refinancing was the primary driver in falling median credit scores. The median credit score for refinancing actually rose from June 2016 to October 2016, and then fell 27 points to reach 725 in April 2017. Median credit scores for home purchases also hit 725 in April 2017, but only fell four points from October to reach that mark. You can check your credit score and read your credit report for free within minutes using Credit Manager by MoneyTips.
The data shows a similar cycle between October 2014 and July 2015, where the median score for refinancing increased and broke away from the median credit score for home purchases, only to fall back to the same level.
Why would these cycles occur? It may relate to differences in supply and demand.
For home purchases, supply and demand are dictated by the number of available homes in the price range of potential homebuyers, the number of buyers competing for those homes, and the general financial conditions of those homebuyers. With refinancing, the number of available homes or buyers is not a factor – you only care about your home and its current value.
Refinancing requires a low enough interest rate for you to see a financial benefit. Rates have been relatively low for some time, and many who qualified for refinancing have already done so – leaving lenders scrambling for more business in this segment. Rising home prices and interest rates that are still relatively low make refinancing a reasonable opportunity, but to get the desired loan volume, lenders must find ways to extend loan qualifications in a responsible way.
Lenders and the agencies are not adjusting rules out of empathy – they are proceeding because it's a sound business decision from their perspective.
Recalculating Acceptable Risk
While lenders may be willing to extend the DTI limit to attract more customers, they're not willing to simply open the floodgates as in the pre-crisis days. There is still genuine business incentive – and regulatory pressure – for lenders to accurately gauge borrowers' ability to pay.
Fannie Mae made this clear, noting that over a decade of research has shown that borrowers that fall into the 45% to 50% DTI range are a relatively good risk and not likely to default. Many have mitigating factors such as significant down payment funds or financial reserves.
In order to maintain the same risk ratio, it's possible that borrowers with a higher DTI ratio — but an otherwise stellar credit history — could receive a mortgage loan over a borrower with a DTI ratio below 45% but with other extenuating factors, such as a history of periodically missing payments. The DTI shift is increasing the pool of potential applicants, but not necessarily the number of approved borrowers.
These changes may help you to qualify for a mortgage, especially a refinancing loan, but in the end you still have to qualify based on your collective financial metrics.
Lower credit score thresholds and greater acceptable debt levels may make it easier for you to buy or refinance a home, but you need to consider all factors carefully before taking on a new mortgage. Just because you have the ability to act doesn't mean you should.
For refinancing, start by setting your objective. Are you simply trying to lower your monthly payments? Pay off your loan earlier and save on total interest cost? Remove private mortgage insurance? Once your objectives are clear, it's relatively easy to use online refinance calculators to determine if your desired benefits are greater than the refinancing costs.
You must be equally cautious when buying a home. Don't be tempted to buy a larger, more expensive home than you need – especially when you are now able to qualify because your current debt load is considered to be less of an obstacle. The bank may have decided that you will be able to repay the debt, but can you realistically agree? Map out your future budget assuming occasional large, unexpected expenses to verify that you are likely to avoid dangerous debt levels.
If you find that these new conditions are in your favor, congratulations! Feel free to take advantage of your new opportunity. Just don't let it take advantage of you.
MoneyTips is happy to help you get free mortgage and refinance quotes from top lenders.