Less-stringent standards open options for home buyers

Kenneth Harney
Kenneth Harney

Here’s an important question for anyone hoping to buy a home next year but who isn’t quite confident about qualifying for a mortgage: Is it true that lenders have eased up on certain key requirements, making it simpler for first-time buyers and others who can’t pass all the strict tests to get approved?

The good news answer is yes. A recent survey of banks and mortgage companies by giant investor Fannie Mae found that a record number of lenders report that they have relaxed at least some requirements for mortgage clients.

In recent months, standards on debt-to-income ratios, minimum down payments and student loan debt have been made less stringent. Both Fannie Mae and fellow mega-investor Freddie Mac — who are key to the mortgage market because they set the guidelines and buy vast quantities of the mortgages originated by banks and mortgage companies — have taken steps to accommodate a wider swath of home buyers.

Debt-to-income changes are at the top of the list. Under previous rules, your total monthly debt load could not exceed 45 percent of your monthly household gross income. Under the new rules, your total monthly debt can now go to 50 percent. With Federal Housing Administration (FHA) loans, you can push it even higher — 55 percent or 56 percent — provided that other aspects of your application are strong.

The net effect of the debt ratio policy change? “This is huge,” Paul Skeens, president of Colonial Mortgage Group in Waldorf, Maryland, told me last week. “It makes it much easier for a lot more people to qualify.” Often they’re younger buyers carrying the typical burdens of starting new households along with heavy student debt. They’re also families who’ve survived challenging economic times and are paying off lingering credit card balances and other bills.

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Fannie Mae’s recent change in the way it handles student loans for calculating debt ratios is another big deal. In cases where mortgage applicants are covered by income-based reduced-repayment plans, and their artificially low payment is listed on their credit reports, lenders now have the option of qualifying them on the basis of that reported amount.

About 5 million Americans participate in reduced-repayment plans. Under previous rules, lenders were forced to impute payment terms for borrowers using these plans. Even when credit reports indicated the borrowers were paying little or nothing, lenders computing debt ratios were required to factor in monthly payments equal to 1 percent of the outstanding balance on the student debt. Say the reduced repayment plan cut the required payment to $75 or to zero. Instead of adding 1 percent of the student loan balance to the applicants’ monthly debt calculation, lenders can now use the actual amount being paid under the plan — zero if the credit report says zero.

Down payment minimums also have been slashed, with many lenders now requiring just 3 percent down on conventional mortgages. FHA still requires 3.5 percent. A handful of lenders are offering 1 percent or zero-down conventional loan options, where they provide gifts — guaranteed non-repayable and no hike in interest rate or fees — for certain borrowers, typically those with solid credit histories. One large Midwestern bank made a splash last month with a zero-down mortgage plan that also includes a gift of up to $3,500 toward closing costs.

What about credit scores? Any easing going on there? Not so much, but you have to look below the surface of the reported statistics to see what’s really happening. Though the average FICO credit score for home purchase loans at Fannie Mae and Freddie Mac in October remained near where it’s hovered for years — an elite 754 — the reality is different. According to Ellie Mae, a software and analytics company that tracks terms on new mortgages, nearly one-third of purchase loans closed at Fannie and Freddie in October carried FICOs below 700. Twenty percent had FICOs between 650 and 699. And a small but noteworthy few (0.64 percent) even had scores below 600.

The takeaway: Be alert to the changes underway. Standards are not necessarily as strict and exclusive as you may assume. It all depends on what your application looks like in total. If you’ve got solid “compensating factors” — maybe a low debt ratio or higher than typical down payment or reserves — your sub-par credit score may not be the deal-killer to a home purchase you assumed it would be.