If you’ve got a low FICO credit score but believe you can handle monthly mortgage payments instead of rent, here’s some potentially good news: The government is willing to give you a better shot at obtaining a low-down-payment home loan from the Federal Housing Administration.
Under a key policy change that took effect last week, lenders nationwide have more leeway to approve mortgages to borrowers who qualify under FHA’s underwriting guidelines but may have below-par FICO scores. Some analysts say the revised approach could create a pathway for as many as 75,000 to 100,000 new loans a year to borrowers who are now frozen out of consideration.
FICO credit scores run from 300, considered the highest risk of default, to 850, the lowest risk. Though FHA for years has accepted applicants who have FICO scores in the 500s, the practical reality has been that most lenders ignore borrowers whose scores are under 620 or even 640. Lenders have avoided low-FICO borrowers in large part because FHA itself has employed a statistical evaluation system that scrutinizes — and sometimes severely penalizes — banks and mortgage companies that make what FHA considers too many “high-risk” loans compared with other lenders active within the same geographic area.
Under the revised policy, lenders will be judged under a fairer metric. This will allow companies located in communities with large concentrations of people with below-average FICO scores — these people tend to include young, first-time buyers, minority households and moderate-income working families — to make loans without fear of being penalized solely because of their business focus.
“This is going to really open the doors — I think it’s a huge step in the right direction,” says Clem Ziroli Jr., president of First Mortgage Corp. in Ontario, Calif. “There are a lot of people out there who have good credit but low FICO scores simply because they lost their jobs during the recession” and got behind on paying bills. “They are working two jobs. They’ve been slowly rebuilding their credit and have been saving money for a down payment. They are good risks” — they’re not going to mess up on mortgage payments. Equally important, Ziroli told me, they are eager “to build wealth by owning a home” rather than paying rent to a landlord. Ziroli’s company originates roughly 7,000 FHA-insured loans a year, many to Latino and African American first-time buyers.
David H. Stevens, president and chief executive of the Mortgage Bankers Association and a former head of the FHA, says the revised policy should help some borrowers whose FICO scores in the low 600s and upper 500s have barred them from obtaining any type of mortgage, FHA or otherwise. But those who fully qualify under FHA’s regular underwriting standards — reliable income, acceptable debt-to-income ratios, solid ability to repay — “will now be more likely to find some lenders who will do their mortgages.”
That’s significant, he said. Even so, many lenders will not rush in and immediately start doing more low-FICO loans. They’re going to wait and watch how FHA treats lenders that do increased volumes of these mortgages.
“So this emphasizes the importance of shopping,” Stevens said in an interview. If the first couple of lenders say no, mortgage applicants should keep shopping until they locate a lender that — encouraged by the new flexibility from FHA — says yes.
Why is the government opening FHA’s doors wider for buyers who previously would have been rejected? In large part it’s because just about everybody — including Federal Reserve Chair Janet Yellen, prominent economists and financial experts — agrees that credit standards have gotten too strict in the years since the bust, especially given the recent payment performances of borrowers.
Brian Chappelle, a principal at the housing consulting firm Potomac Partners and a nationally known expert on FHA, told me via e-mail that mortgages with low FICO scores originated during the past two years “are performing better than the total mix of FHA business [including loans with much higher scores] from 1999 through 2011.” Serious delinquencies of 90 days or more where applicants had FICOs below 640 were at just 1.82 percent as of June 30.
The takeaway here: Just because your credit reports and scores continue to bear the wounds of the recession and financial crisis, don’t assume you can’t buy a house. Shop aggressively among FHA lenders in the coming weeks and months, and you’re likely to find a better reception than you might have feared.
Ken Harney’s e-mail address is email@example.com.