No one wants to return to the days when anyone could get a mortgage even if they couldn’t realistically afford the payments.

Yet every few months or so, concern bubbles up again about unconventional loans and the potential for another housing crisis. Tweaks to lender guidelines and new credit scoring models sometimes create consternation among consumers and the lending industry about access to credit becoming too easy or too difficult.

The global coronavirus, which initially dropped mortgage rates to new lows, led to a rush to refinance that overwhelmed lenders. Rates increased when lenders couldn’t handle the volume of loans. Now that the pandemic is impacting the United States, borrowers should anticipate a slowdown in mortgage closings because everyone is working from home and still attempting to process an overload of loan applications.

Generally, mortgage borrowers in 2020 need to do two things: understand the loan they’re applying for and be able to demonstrate their ability to repay it.

“I’m a huge fan of loan preapprovals and I think everyone should get two or three unbiased opinions from lenders about mortgage options before they fall in love with a house,” says Anna DeSimone, author of “Housing Finance 2020: New Mortgage Programs for the New Generation of Homebuyers,” and a housing finance consultant in New York City. “It’s like going on a job interview where you can ask and answer questions.”

Mortgage approvals are generally based on your FICO credit scores, your loan-to-value (which varies according to the size of your down payment and the appraised value of the house) and your debt-to-income ratio. Your debt-to-income ratio is a measure of the minimum payments on your credit card debt, loans and housing payment compared to your gross monthly income. Meeting in person with a lender can help you understand what it takes to qualify for a mortgage.

“If you just complete an online form for a loan, that won’t capture some of the compensating factors that a lender may consider in your favor,” says DeSimone. “For example, an automated system may require a credit score of 680 for a loan with 5 percent down, but if you have a retirement account with six months’ worth of mortgage payments that could allow an approval with a lower credit score.”

DeSimone says mortgage applications today list 20 different types of acceptable income, such as seasonal work, rental income from boarders and part-time jobs — in greater recognition of the reality of the ways people earn money. The income must be documented with bank statements or other paperwork.

“Lenders have different standards and will offer different rates and programs, so there’s no substitute for shopping around for a loan,” says Guy Cecala, chief executive and publisher of Bethesda-based Inside Mortgage Finance Publications. “It’s important to talk to more than one lender and to do it before you’re ready to apply for a loan because the credit score the mortgage lender pulls tends to be more comprehensive than the one you see online. It can be hard to calculate your own debt-to-income ratio because the lender only counts some types of debt.”

The average FICO score for approved mortgage loans has remained relatively steady in recent years, ranging from 723 in 2017 to 731 in 2019, according to Joe Tyrrell, chief operating officer of Ellie Mae, a technology provider for mortgage companies headquartered in Pleasanton, Calif. The average debt-to-income ratio for approved mortgage loans was 39 percent in 2017 and 38 percent in 2019.

“Even though access to home buying has improved with the availability of more low-down-payment loans, lenders are not compromising on the credit quality of applicants,” says Tyrrell.

Federal Housing Administration (FHA) loans have more lenient requirements than conventional loans, which are purchased by Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac are the government-sponsored entities that operate under the authority of the Federal Housing Finance Agency and purchase the majority of mortgage loans made in the United States.

“FHA loans are a great option for people with lower FICO scores,” says Jeremy Sopko, CEO of Nations Lending, headquartered in Independence, Ohio. “The average FICO score for our customers is 680 but we also provide loans to people with credit scores of 580 and below. In that case, though, we expect them to come to the table with their own funds for the down payment. If someone has a low credit score and they’re getting their down payment from their family, then they don’t have any meat into the loan.”

FICO score changes

Fair Isaac Corp., which issues FICO credit scores, recently announced new credit scoring models (FICO 10 and FICO 10T) that will be used by all three credit reporting bureaus (Equifax, Experian and TransUnion) by the end of the year. FICO scores impact mortgage lending in two ways. First, a low score can disqualify a borrower from many loan programs. Second, the interest rate paid for conventional loans depends on FICO scores. The lowest mortgage rates are reserved for borrowers with a credit score of 760 or above, according to MyFICO.com.

“Mortgage lenders use an older FICO scoring model rather than the most recent model, so the impact of the new scoring model isn’t likely to be felt right away,” says Tyrrell. “But the new FICO 10T version could have an impact on future borrowing because it looks at trended data rather than a snapshot of what a borrower looks like right now.”

Trended data examines the pattern of debt repayment over two years. Consumers who pay credit card bills in full each month are likely to see a boost in their credit score, while those who carry a balance or pay off their debt and then accrue more debt are likely to see a drop in their credit score with the new model, according to Tyrrell.

“Fannie Mae and Freddie Mac have a mandate to change credit score models, but the process is just beginning,” says Ed Pinto, director of the American Enterprise Institute’s Housing Center in Washington, D.C. “They have three years to make the change and a two-year implementation period, so FICO can come out with anything they want but there will be a delay on the mortgage end.”

Much of the blame for the 2008 financial crisis fell on unusual mortgages, such as “choose-your-own-payment” and no-income verification loans, also known as “liar’s loans.” While those types of loans are not widely available, in 2019 unconventional loans represented $52 billion in loan volume, the highest level since the housing crisis, says Cecala. However, that’s still a relatively small number — less than 3 percent of the overall mortgage volume for the year.

Today’s unconventional loans include those that rely on bank statements instead of tax returns to verify income and asset-based loans for high-net-worth families, says Tyrell, but they’re not readily available to most borrowers.

“Before the housing crisis, more than a third of all loans were unconventional and they were offered by all lenders as part of their product mix,” says Cecala. “Now most lenders are doing a good job underwriting the loans, especially because there’s so little investor interest in these loans that the lenders hold them themselves. That imposes discipline because the lenders don’t want to lose money. For instance, you do see some interest-only loans, but they’re typically only approved for well-heeled buyers with high incomes and high credit scores.”

One measure of the state of mortgage lending is delinquencies, which refer to loans with payments that are 30 days or more past due. In January 2020, mortgage delinquencies hit their lowest level on record, dating back to 2000, according to Black Knight, a software and data analytics provider. The number of loans with late payments declined 14 percent in January 2020 compared with January 2019, an indication of both a strong economy and high standards for loan approvals.

“Today’s unconventional loans aren’t as risky as in the early 2000s because lenders are more careful now and won’t loan 100 percent of the value of the home to someone based on their bank statements,” says Sopko. “Now you’ll need a down payment or home equity of 30 or 40 percent for those kinds of loans.”

Changes in 2021

The existence of fewer risky mortgages today stems from post-crisis regulations as well as lender skittishness over the massive losses they incurred during the housing crisis. One part of those regulations protects borrowers from predatory lending and provides safety for lenders from lawsuits as long as they follow the rules for a “qualified mortgage” or “QM” loan. QM loans meet a long list of requirements, such as no balloon payments, no interest-only periods and set a maximum debt-to-income ratio of 43 percent.

However, loans that would be purchased by Fannie Mae and Freddie Mac are exempt from the maximum debt-to-income ratio of 43 percent set by the QM rule — if borrowers met all other requirements to demonstrate their ability to repay the loan. That exemption is scheduled to be lifted in January 2021.

“That 43 percent was set because it’s basically the mortgage standard without any compensating factors, but if you had good income and good reserves or a down payment of 50 percent, a ratio higher than 43 percent might be okay,” says Cecala.

The possibility of this exemption, known as the “QM patch,” expiring without modification by the Consumer Financial Protection Bureau is unlikely, according to Cecala and most industry experts. The concern, says Cecala, is that fewer borrowers would qualify if the maximum debt-to-income ratio of 43 percent was enforced for conventional loans.

On the other hand, some observers worry the CFPB could get rid of the debt-to-income ratio requirement.

“If the debt-to-income ratio requirement is eliminated, then lenders are less likely to manage risk,” says Pinto. “My concern is that too-easy credit could return.”

Another possible outcome if the QM patch is lifted next year would be an increased number of private non-QM loans, says Sopko, which could be risky.

Changes to loan regulations, new FICO scoring models and the return of unconventional loans are all something to keep an eye on over the next year or two, says Sopko. In the meantime, mortgage borrowers should be sure they understand their credit and finances before they begin to look for a home.

Some advice for borrowers applies no matter what happens in the mortgage industry, such as:

Check your credit report. Get your free credit reports from each of the credit bureaus at www.annualcreditreport.com to look for errors. You can also pay for a credit score at that time or get a free credit score from your bank or credit card company, but keep in mind that score is likely to be different from the score a lender will see.

Prepare your documents. Many loan applications are handled online with secure portals where you can upload your documents. You’ll need to know how to access your most recent paystubs, tax returns and statements for all your bank and investment accounts. If you’re self-employed or rely on alimony or child support for income, you’ll need additional documentation.

Check for down payment assistance programs. You can check with your state or local government or with DownPaymentResource.com. DeSimone says there are programs for people with incomes higher than $100,000 in 43 states. “Not checking for home buyer programs is like accepting a college admission without asking about financial aid,” she says.

Shop for loan information. Take a copy of your annual credit report and credit score to several lenders so they can get a general idea of your credit profile and your loan options without requesting a credit report, recommends DeSimone. If you appear to be applying for multiple loans, that can damage your credit score, so wait to apply until you’re ready to seriously shop for a home.

Explore all your loan options. Borrowers who are low on cash have a variety of loans available, including some with zero down payment required (such as VA loans for veterans and USDA loans for buyers in rural areas) and low down payment loans from FHA, Freddie Mac and Fannie Mae. Many financial institutions have special loan programs for first-time buyers and repeat buyers.

Avoid overextending your budget. Pinto says he worries that weaker buyers could be in danger if a recession hits, particularly since the United States is in the ninth year of a boom cycle. “Don’t stretch to buy,” says Pinto. “Try to stay within your budget to reduce your exposure to debt or come up with a bigger down payment so you have more equity.