Does no credit score mean no mortgage? What happens if you want to buy a house and don't have a credit score?
It may seem strange that in a financial system where credit scores are part of everyday life that it's possible to get a mortgage without a credit score. It turns out that such a thing is possible.
No FICO Score? There Are Alternatives
Applicants for government-backed home loans or products from Fannie Mae and Freddie Mac (in other words, most applicants) are not harshly penalized if they don't use enough credit to generate a FICO score. In that case, lenders compile a report based on alternative or non-traditional credit sources.
The idea of these unconventional credit measures is not to hide bad credit; it's to assure that individuals with "thin" credit files, generally those new to the financial system and with few traditional credit events, can have a fair shot at a mortgage.
In other words, you need to show good credit to get a mortgage and unconventional credit measures may work in the absence of traditional credit scores.
What Is Non-traditional Credit?
What might fall into the realm of alternative credit?
You probably have bills that you pay every month – phone, Internet, rent, etc. For instance, let's say you rent a single-family home from a private landlord, but the landlord does not report your payments to a credit reporting agency. In this situation you're paying your bills, but you're not getting the benefit of a good credit report.
For mortgage programs that allow non-traditional credit, lenders order a non-traditional credit report from a credit reporting agency. Fannie Mae guidelines say that the agency must do the following:
- Check all three major credit repositories and attempt to verify the borrower's credit history.
- Interview the borrower to identify credit use over the most recent past 12 months.
- If the lender already has a list of accounts from the borrower, the agency doesn't have to interview the applicant. Instead, the lender must immediately contact the individual credit providers to verify the payment histories.
- Consider only accounts requiring periodic and regular payments -- at least every three months.
- Pass on all information collected after contacting applicants' credit references.
- Indicate if information obtained meet Fannie Mae criteria for nontraditional mortgage credit reports.
Note that the lender might require you to provide proof of payment (in order to establish that no one else was paying your rent for you, for example). You might in that case be asked for 12 months of canceled checks proving that you paid your own rent or receipts from your landlord if you paid in cash.
Disadvantages of Non-traditional Credit
While Fannie Mae, Freddie Mac and the FHA, USDA and VA all accept non-traditional credit, other lenders are not required to. In addition, even those loan programs that allow non-traditional credit impose limitations. For example, Fannie Mae imposes limits on borrowers who qualify with non-traditional credit.
- Property must be a one-unit primary residence.
- Cash-out refinances are not allowed.
- The income used to qualify the borrower cannot come from self-employment.
- The maximum DTI ratio is 36 percent
A second disadvantage is that non-traditional credit reports are more expensive than traditional computer-generated reports, because actual humans have to check the accounts by contacting the creditors and examining the applicants' documents. The biggest disadvantage, however, is the fact that applicants relying on non-traditional credit undergo scrutiny that those with traditional credit do not. For example, late payments to utility companies or bounced checks don't appear on a traditional credit report – but they're front and center on non-traditional reports and can derail your attempt at a mortgage.
How to Build Credit
The main thing when establishing credit is to remember that you can't afford to make a mistake – a single late payment may not matter much when you have ten years of solid credit history behind you and a half-dozen open accounts. But when you miss the second payment of a brand-new account, and you only have two accounts, it will hit you hard. So use small amounts and pay them off every month, and pay them on time.
One of the best ways to build a nice credit history may be available to you already – your first mortgage.