Low Mortgage Rates Little Help to People with Shaky Credit

Is it a buyer's market for real estate? On the surface, this may appear to be true. Home prices are still below peak levels, and mortgage rates are near all-time lows. Even the acceptance rate of mortgage applications has improved. This all may sound like a buyer's paradise, but some would-be home owners are locked outside the gates of that paradise, unable to get in because of less-than-perfect credit.

Several Factors Favor Buyers

First the good news. Here are some reasons why this is a great time to buy a home:

  1. Prices are recovering, but are well short of peak values. According to the S&P/Case-Shiller National Home Price Index, prices have been rising over the past couple years, and yet they are still about ten percent cheaper than when they peaked back in July of 2006. In other words, the housing market looks healthy, but in most parts of the country you shouldn't have to pay peak prices.
  2. Mortgage rates are among the lowest in history. According to data from the Federal Reserve, 30-year fixed mortgage rates averaged 3.71 percent in January of 2015. This is less than half of the historical average of 8.45 percent, and not far off from the all-time low of 3.35 percent reached in late 2012.
  3. Mortgage approval rates are high. At least on the surface, it appears that relatively few applicants are getting turned down. According to data from the Urban Institute, the percentage of mortgage applications being denied has trended down in recent years, to a historical low of around 14 percent.

There is just one problem - a new measure of the mortgage denial rate shows that it is actually much harder to get a mortgage these days than traditional measures would suggest.

Getting a Mortgage Is Harder than it Appears

Traditionally, the denial rate for mortgages was determined simply by taking the number of applications that were turned down as a percentage of total applications. However, in a recent paper, researchers from the Urban Institute suggest that this measure of mortgage denials can be misleading, because the quality of applicants changes over time.

For example, during the peak of the housing boom, underwriting standards were relatively lax, so lower-quality applicants were encouraged to try to get a mortgage. Since then, with standards having tightened and mortgage companies not as likely to target lower-quality applicants, the average quality of mortgage applications has improved. The Urban Institute researchers theorized that this might account for the decline in the denial rate.

To test this, they looked at the denial rate among applications with less-than-perfect financial circumstances. They studied applicants with FICO scores under 700, a loan-to-value ratio over 78 percent, and a debt-to-income ratio exceeding 30 percent. Those are pretty high standards, and yet the denial rate for these applicants hit 43 percent.

So, this is the flaw in the buyer's paradise: only nearly-perfect applicants can be confident of getting a mortgage. If your FICO score, loan-to-value ratio, or debt-to-income ratio fall short of those high standards, you have a significant chance of being turned down.

Denied a Mortgage? Take Action

If you have already experienced this, don't think you are shut out of the housing market completely. There are a number of actions you can take:

  1. Ask for specifics on why you were turned down. Don't just take "no" for an answer - make sure you also find out "why not." This will tell you what aspect of your application you need to address. Sometimes, this is just a technical matter, such as a missing piece of information.
  2. Address any problems on your credit report. If a low credit score is the obstacle, find out what is dragging you down. Then you can work to clear up any errors, and put right any missing payments.
  3. Consider a larger down payment. Since lower loan-to-value ratios was one characteristic of mortgage applicants who fared better, see if you can improve your chances by applying for a loan with a lower loan-to-value ratio. This can be achieved by saving up a bigger down payment or buying a cheaper house.
  4. Try other lenders. Lenders do not all follow the same underwriting standards, and some aspects of the process are subjective. If one lender turns you down, don't give up till you have tried others.
  5. Build a better payment history. If none of the above works, get to work on improving your chances in the future. It may take a few years, but establishing a reliable payment history should improve your chances next time around.

The analysis by the Urban Institute shows that mortgage approval is tough to come by unless you have nearly ideal financial circumstances. For everyone else, getting approved might take some extra effort, but when you remember how favorable prices and especially mortgage rates are, that effort should seem worth making.

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