Credit, debt dings don’t always doom mortgage applications

Data from tech company shows you still might qualify for a mortgage with low FICO score or debt

Feb.February 03, 2017 11:30 AM

How tough is it to get approved for a mortgage? How low can your FICO credit score go before your lender shows you the door? And how much monthly debt can you be shouldering — credit cards, student loans, auto payments — but still walk away with the mortgage you’re seeking?

You might be surprised. New data from technology company Ellie Mae, whose loan application and management software is widely used in the mortgage field, reveals that even if you’ve got what seems to be a deal-killing low FICO score or you’re carrying a mountain of debt, you still might have a shot at qualifying for a mortgage to buy the house you want.

Consider some of these findings from Ellie Mae’s latest sampling of recently closed loan applications nationwide:

— FICO scores on most successful applicants remain well above historical averages, but significant numbers of home buyers are squeaking through with sub-par scores. (FICO scores run from 300 to 850, with the upper end of the scale indicating lower risk of default.) Though the vast majority of lenders shy away from — or absolutely rule out — applications with FICO scores below 620 or 640, applicants with scores that are sometimes 100 points below are being approved and funded.

Roughly 5 percent of all Federal Housing Administration (FHA) insured loans closed in December had FICO scores below 600; 3.4 percent had FICOs between 550 and 599, and 1.5 percent scored between 500 and 549. FHA, whose role in the marketplace is to provide a doorway to homeownership for applicants who could have difficulties being approved for “conventional” loans — those eligible for sale to giant investors Fannie Mae and Freddie Mac — still pulls in plenty of applicants with solid scores. Thirty seven percent of approved applicants had FICO scores of 700 to 799 in December. But the majority — 56 percent — had FICOs between 600 and 699.

Meanwhile, even in the more exclusive conventional marketplace, there are big variations in acceptable scores. Thirteen percent of home buyers whose conventional loans closed in December had FICOs ranging from 650 to 699.

— Debt-to-income (DTI) ratios have more wiggle room in them than you might assume. Though the typical buyers whose conventional loans were closed in December had “back end” debt ratios averaging 35 percent, at FHA the average was 42 percent. (The back-end DTI ratio measures buyers’ total monthly debt obligations, including payments due on their new mortgage, against their monthly gross income.) Depending on other factors in the application, conventional lenders generally have flexibility to push the ratio to 45 percent, while FHA lenders can go considerably higher in some cases, even above 50 percent. That’s scary high for most people, but loans like these are getting done routinely.

— Down payments can be much smaller than a lot of buyers sitting on the sidelines might think. The average down payment on VA (Veterans) mortgages in December was just 2 percent — and that’s higher than the VA’s bare minimum requirement, which is zero down. FHA’s minimum is 3.5 percent and the typical approved applicant came close to that at 4 percent down. The average conventional down payment on home purchase mortgages was 20 percent but both Fannie Mae and Freddie Mac offer loans that require just 3 percent down. A few lenders — most prominently Quicken Loans — have cut that to as little as 1 percent down.

So how do buyers with sub-par FICOs, skimpy down payments and high DTIs manage to get a mortgage? The key is this: They don’t have these negative factors rolled into their applications all at once. If they did, they’d be rejected. If they’ve got a weak FICO, they need strong “compensating factors” elsewhere in their application to counter-balance the credit score deficiency. Maybe it’s a larger down payment than typical, a lower than average DTI or higher bank reserves. Maybe you’ve got a co-borrower with solid financials to ease the lender’s concerns. Maybe you are able to afford a slightly higher rate on the loan. Whatever the compensating factors are, you absolutely need them.

John Walsh, president of Total Mortgage Services, a Connecticut-based lender active in 44 states, told me “it’s all about the total picture,” not just one glaring negative. “The whole application has to make sense.” So if you look terrible in one area of your application, don’t give up. If you can bring other strengths to the table, you’ve got a chance — even in a tough lending environment.

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