Fannie Mae recently announced that a minimum credit score of 620 will no longer be a requirement for loan approval. This announcement has generated many questions within the industry. The straightforward answer is that credit scores are still a key factor and continue to hold the same level of significance as they did prior to this announcement.
How will DU approval now work?
The underwriting system will now take what they are calling, a more “holistic” approach in evaluating credit. They will now take into consideration:
- Overall debt history by looking at Trended Data to identify patterns and trends.
- Details regarding a steady source of income and the duration of this income stream.
- Alternative data such as the payment history on rent and utilities
- “Financial Habits” – a history of low balances and no or minimum derogatory marks.
Why do credit scores still matter?
Several reasons. For one, lenders can still set their own credit score requirements. Even though the minimum score requirement is going away, Fannie Mae still requires scores to be utilized. The LLPA (Loan Level Pricing Adjustment) is still based on credit scores as is PMI (Private Mortgage Insurance). The lower the scores, the higher the rate and pricing. Even if a person with a score under 620 may now be eligible for approval, the added additional costs could make the loan prohibitive.
In other words, lenders will have increased flexibility regarding the types of credit information they may consider when evaluating a borrower, while essential risk management guidelines will remain in place.
Who will benefit the most?
Borrowers with thin files (those with little or no credit history), and those with scores below 620. For borrowers with scores over 620 this new standard will have little to no impact.
Why are these changes happening?
According to FHFA Director Bill Pulte it is “to modernize the mortgage process by looking beyond traditional credit.” He feels it will expand access to homeownership by focusing on “the overall financial picture” rather than basing the decision on a single credit score. He confirmed that “this is not a loosening of standards but a modernization effort.”
As previously noted, credit scores remain a crucial factor in the approval process. Even for individuals with limited credit history, they must demonstrate a consistent income, manageable debt levels, and a history of on-time payments through alternative credit sources to be considered for approval. Lenders may also have their own specific requirements or overlays regarding credit scores.
Will these changes have an impact? For some applicants, certainly. The extent of the impact will become clearer over time. Ideally, this represents a positive step toward expanding access to homeownership.