Consumer credit reports and scores loom large on the list of items required by most lenders for a mortgage loan application, but some would-be home buyers who are otherwise financially ready to purchase a home lack a robust credit history.
Whether you prefer to avoid using credit cards, are too young to have years of loan repayment proof or are a newcomer to the United States, it's possible that a lender will check for a credit report and come up empty-
handed or with what's known as a "thin file" instead of a lengthy financial profile.
Even in today’s tight lending environment, though, you can often find a banker willing to work with you to approve a loan now or consult with you to establish a path to a mortgage approval.
“Nontraditional lending programs are available from a variety of sources for people who don’t fit the standard mold of borrowers,” says Becky Walzak, president of rjbWalzak Consultancy, a risk management advisory company for lenders in West Palm Beach, Fla. “If you have good assets and good income you can go to any lender and discuss your options for creating a nontraditional credit report.”
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Most individuals have misconceptions about the strength of their credit history, says Marietta Rodriguez, vice president of national homeownership programs for NeighborWorks America in Washington.
“You need to find out what your credit score is and find out what behavior impacts your credit score,” Rodriguez says. “Any nonprofit housing counselor can do what we call a ‘soft credit pull’ which won’t damage your credit score since it’s just for information rather than an indication that you’re applying for credit. The counselor can work with you to build your credit history.”
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Rodriguez says many consumers self-select themselves out of housing counseling, believing that these counselors exist to help only low- or moderate-income people, but she says most people can benefit from credit and home-ownership education.
Low credit score
or no credit score?
While many lenders can help borrowers who lack a credit score, Jim McQuaig, branch manager of Churchill Mortgage in Herndon, Va., says that it’s important for consumers to recognize the difference between the lack of a credit score and a low credit score.
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“If you don’t have a credit score, it’s possible to build a credit profile with a nontraditional credit report based on things like your rent payments and utility bills,” McQuaig says. “If you have a low credit score, it can be harder to get a loan, particularly with conventional financing. Consumers with a low credit score pay a higher interest rate and fees even if they are able to get a conventional loan approval.”
Conventional loans, which meet guidelines established by Fannie Mae and Freddie Mac in addition to rules established by individual lenders, require risk-based pricing that increases your interest rate according to your credit score. Borrowers with a credit score of 740 or above pay the lowest interest rates. According to CreditKarma.com, good credit is generally considered to be 720 and above. A credit score of 620 or 640 and above is typically required by most lenders for any mortgage loan approval, even for government-insured loans such as VA and FHA loans.
Some consumers have a low credit score in spite of financially smart behavior, McQuaig says.
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“We see a lot of borrowers with low credit scores because we’re the only national mortgage lender endorsed by Dave Ramsey, who focuses his financial advice on debt-free living,” McQuaig says. “People are encouraged to pay off their credit card debt and loans and then close their accounts. While it’s great financially to do that, the current credit scoring model won’t see those paid-off accounts, which will drive down your credit score.”
What will it take for homeowners to crack open the ‘credit box’?
McQuaig says it’s possible to improve your credit score within a month or two with the help of a lender who can review your report and suggest some strategic moves.
“Unfortunately, while it’s great to live debt-free, if you want to borrow money for a mortgage, you have to comply with the credit rules and have a decent credit score,” McQuaig says. “You can’t win a football game playing by baseball rules.”
Building a nontraditional credit profile
If you’re among those without a credit report at all, consult a lender to discuss what financial paperwork you need to produce to create a nontraditional profile. While Walzak says any lender can help you, you’re more likely to find personalized assistance from a nonprofit housing counselor, your bank, a community bank or a credit union than one of the larger lenders.
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“As a credit union, we don’t gravitate to a boilerplate yes or no decision on a mortgage,” says Joe Talmadge, assistant vice president of mortgage lending for Northwest Federal Credit Union in Herndon, Va. “We do need some type of payment history but we can look at our borrowers’ overall finances and determine whether there are enough compensating factors to make a loan approval possible.”
McQuaig says a nontraditional credit profile for conventional financing must include at least 12 months of on-time rent payments plus three other bills that can be verified by a third-party vendor. For example, you might be able to use your auto insurance premiums, cellphone bill, utility bills, cable bill or even your Netflix account to establish a credit history.
“Typically, you need to have paid these bills for at least 12 months on a regular basis,” McQuaig says. “Even a regular savings deposit might work, but usually you can’t include anything automatically deducted from your paycheck since that doesn’t demonstrate personal responsibility for a payment.”
Mortgage applicants may benefit from changes in credit-scoring system
The important thing for people to understand, says Rodriguez, is that “you don’t need to get a credit card and go into debt to build a credit history.”
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Walzak says most traditional lenders follow the “rule of two.”
“They want to see two years of housing history, two years of tax returns and two years of employment history as a sign of your stability as a borrower,” Walzak says.
Loan qualifications for nontraditional borrowers
Some lenders have established lending practices designed to reduce emphasis on your credit score.
“At SoFi, the biggest piece of our loan evaluation process is your ability to repay the loan,” says Dan Macklin, vice president and co-founder of SoFi, a consumer lender based in San Francisco. “What’s most important to us is your cash flow and whether you can afford the monthly payments.”
While SoFi requires a credit report and a credit score, the company is more flexible than some other lenders and doesn’t have a minimum credit score requirement for a loan approval.
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“We’ll look at more than just your salary and credit and we’re willing to include a variety of income sources to evaluate your full financial picture,” Macklin says.
SoFi’s mortgage loans, available in D.C. and Maryland but not yet in Virginia, require a 10 percent down payment but do not require mortgage insurance.
Talmadge says that one caveat for borrowers with a nontraditional credit history or a low credit score is that if they choose to make a down payment of less than 20 percent on a conventional loan, they’ll also need to be approved by a private mortgage insurance company.
“Mortgage insurance companies tend to be more traditional, so it can be harder to get a loan approval from them,” Talmadge says.
Right now, Rodriguez says, Federal Housing Administration loans are the most lenient for borrowers with credit challenges, but those loans require mortgage insurance for the life of the loan that can make the monthly payments higher than conventional loan payments.
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Northwest Federal Credit Union has a variety of loan programs to meet the needs of members with financial circ*mstances that don’t fit conventional loan guidelines.
“We have credit counselors that work with members to chart a path to establish credit or increase their credit score,” Talmadge says.
He says that after an average of about six months most members can become eligible for a loan.
“Everything depends on the individual lender and the risk you’re presenting,” Walzak says. “If you don’t have much money in the bank, have had three jobs in the past year and are getting a gift for your down payment funds plus you lack a credit history, that’s a lot different than someone who has held the same job for several years, has a solid rental history and money saved for the home purchase and just lacks a credit history.”
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Whether your issue is a low credit score because of a limited credit history or you lack a credit history, it pays to consult a lender if you want to borrow money to buy your first home.
Tips for borrowers with a limited credit history
•Don’t assume you can’t qualify for a mortgage if you have a low credit score because of a limited credit profile — or even no credit score at all. Some lenders are willing to work with borrowers to establish a nontraditional credit profile or to find ways to improve a low credit score.
•A larger down payment, higher levels of cash reserves and verifiable income that can easily cover your mortgage payment can help compensate for credit issues.
•A nonprofit housing counselor can help someone with a low credit score improve their credit.
•Applying for a credit card and using it responsibly can boost your credit score but you can also rely on other sources to establish your financial history, such as your rent payment and other bills.
•Talk to at least two lenders to compare their programs, interest rates, fees and mortgage insurance premiums.
•If you’re turned down for a loan by more than one lender, contact a nonprofit housing counselor for advice.
