Credit Scores: Mortgage Lenders Ease Requirements

According to a report prepared by Ellie Mae, a mortgage technology company, the average FICO credit score for approved mortgage loans dropped to 727 in December 2013. It was 748 a year earlier.

The average credit score for home loans backed by Fannie Mae and Freddie Mac also dropped a little; December 2013 borrowers had an average credit score of 756, down from December 2012's average of 761.

Refinance mortgages backed by Fannie Mae or Freddie Mac were approved with an average credit score of 729 in December 2013; this was a significant drop from the average credit score of 763 in December 2012.

Only 46 percent of mortgage applicants approved had credit scores above 750 in December 2013 while approximately 57 percent of applicants had credit scores over 750 a year earlier.

Mortgage Credit Scores: What's Going On?

Reasons for approving mortgages with lower minimum credit scores include mortgage lenders' growing confidence as the economy improves and mortgage defaults decrease. As rates rise and refinancing activity dries up, lenders may also exercise more flexibility with credit scores in order to encourage more business.

While this isn't life-changing news for would-be mortgage applicants with sub-par credit scores, a mortgage lender's willingness to work with less-than-perfect credit is a positive sign in the aftermath of the recession.

But wait -- there are conflicting opinions concerning how or if mortgage lenders will change their minimum required credit scores for any but the best-qualified applicants. Mortgage applicants with credit problems can expect to encounter glitches on the path to mortgage approval.

Mortgage Underwriting Policies: Out with Overlays -- or Not

Another practice that can limit a mortgage applicant's chances of approval is the use of "lender overlays." Lender overlays are underwriting requirements, imposed by lenders, in addition to the guidelines set out by Fannie Mae, Freddie Mac or the federal government. Overlays create extra hoops for applicants to jump through (or get stuck in).

Some analysts have said that mortgage lenders may be willing to reduce or eliminate lender overlays if economic conditions continue to improve.

So far, most lenders have not reduced or stopped using overlays. Other economists and analysts believe that new federal "qualified mortgage" regulations will encourage mortgage lenders to maintain or further strengthen their mortgage approval requirements.

Lower Credit Scores, Less Cash and More Debt

Unfortunately, the recession has caused home buyers to be less prepared to buy homes. The Ellie Mae report notes that homeowners who wanted to trade up were frequently blocked by a loss of home equity. The report also found that the weak economy made it more difficult to save for a down payment due to low yields on savings and ongoing unstable economic conditions.

Ellie Mae reports that mortgage applicants are also carrying more debt. Average total debt-to-income ratios (DTI) for home buyers were little changed in 2013, but the average total DTI for refinancing rose from 33 to 41 percent in 2013. For FHA loans, the average total DTI was 42 percent. Fannie Mae currently allows manually underwritten standard home loans a DTI maximum of 45 percent.

Based on a moderate pace of economic recovery and mortgage lenders' desire to avoid losses created by unsound mortgage approval guidelines, It's likely that minimum credit score requirements will not change or may be lowered minimally until the economy shows a strong recovery and mortgage applicants can boost their savings and pare down their debt.

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