An alternative route to mortgage approval

Nov 30, 2022 Michele Lerner,HSH.com

alternate-one-way-another-way For many homebuyers, establishing credit came naturally once they began working, applied for a credit card, car loan or paid back student loans. But what about potential homebuyers who don't have a credit score either because they are credit card averse or have yet to build up a substantive credit history -- can they still apply for a mortgage?

The answer is "yes," but "it's exceedingly difficult to obtain a mortgage without a credit score," says Tim Ross, president and CEO of Ross Mortgage Corp. in Royal Oak, Michigan. "Lenders use automated underwriting systems that base a loan decision on certain criteria including a credit score. But there are some non-traditional sources that can be used for credit verification."

Mortgage lenders typically require a credit score of at least 620 or 640 to even consider an applicant for a loan.

Whether you prefer not to use credit cards, are new to this country or are simply a younger borrower who hasn't built up enough credit history, there are some alternative sources mortgage lenders can use to determine your credit risk.

Alternate qualification is only available if a borrower or borrowers actually have no credit score at all. Fannie Mae's guidelines note "The lender must first check all three major credit repositories to verify the borrower’s credit history and confirm that the borrower does not have a credit score. If the borrower’s credit information is frozen at one of the credit repositories, and no credit score is available from any other repository, the lender may underwrite the borrower following the requirements for nontraditional credit. If the borrower’s credit information is frozen at two or more of the credit repositories, the loan is not eligible as nontraditional credit even though no credit score is available. The credit report will indicate if a credit score could not be produced due to insufficient credit."

While most lenders require three or more sources of credit, Clint Madison, a senior mortgage banker with Envoy Mortgage in Walnut Creek, Calif., says, "I've worked with borrowers who have a slim credit file and been able to get them approved for a loan. The first thing we look for would be 12 to 24 months of canceled checks or verification from a landlord of on-time rent payments."

Alternative sources of credit

Here are several other items that can be used for non-traditional credit verification, according to Fannie Mae:

Utility bills for gas, electricity or water as long as they are paid separately from your monthly rent
Cell phone, cable and internet service provider bills
Car insurance, renter's insurance, life insurance payments or medical insurance payments if they are not paid by payroll deduction
Child care or school tuition payments
Payments to local stores, such as department stores, furniture stores, appliance stores
Rental payments for durable goods, such as automobiles

The more evidence you can provide that indicates a history of on-time payments the greater your chances of qualifying. Each borrower on the loan may be required to show as many as four alternative sources of credit.

"You need at least 12 months and sometimes as many as 24 months of payments to prove your creditworthiness," says Ross. "A bigger down payment offsets your credit risk and so does your job stability, your cash reserves and a high income in relation to your debts."

Fannie Mae requires that there cannot be any delinquency on rental housing payments within the past 12 months, and that only one account (excluding rental housing payments) can have a 30-day delinquency in the past 12 months. As well, there can be no credit sources in collections (other than medical collections) or judgments filed against the borrower in the past 24 months.

In addition, if all borrowers on the loan are being qualified using non-traditional credit sources, at least one borrower will need to complete a homeownership education course before the loan closes.

Credit history matters

The reason for your lack of credit history will also impact your ability to qualify for a loan.

"If you're living with your parents and have yet to establish any credit, it's pretty much impossible to get a loan unless your parents are willing to co-sign for you," says Madison. "The parents will need a credit score at a minimum of 660 and you'll need to have at least two months or maybe as much as six months of principal, interest, taxes and insurance payments in cash reserves in the bank."

If you can't fully document a rental history, Fannie Mae also requires that you have 12 months of housing payments as a reserve.

Borrowers who are new to the U.S. may have a credit report from another country. Ross says those credit reports can be used to create a record of bill payments for a loan application.

Fannie Mae requirements say that for non-U.S. citizens or foreign borrowers who lack sufficient credit references in the United States, the lender must use credit references from foreign countries to achieve the required number of nontraditional credit references and establish a nontraditional credit profile.

You may not know your true credit score

Even consumers who have a long enough credit history to produce a score may still need alternative sources of credit when applying for a loan. The Consumer Financial Protection Bureau (CFPB) conducted a study back in 2012 that showed there are discrepancies between the credit score given to a consumer and one reported to a lender.

"This study highlights the complexities consumers face in the credit scoring market," said CFPB Director Richard Cordray in a press release. "When consumers buy a credit score, they should be aware that a lender may be using a very different score in making a credit decision."

Fannie Mae requires that lenders use the following versions of the classic FICO score for both DU and manually underwritten mortgage loans:

Equifax Beacon® 5.0;
Experian®/Fair Isaac Risk Model V2SM; and
TransUnion FICO® Risk Score, Classic 04.

Note: In October 2022, Fannie and Freddie's regulator (the Federal Housing Finance Agency) issued guidelines allowing for the use of credit scoring models other than those listed above. Lenders can now also use VantageScore 4.0 and FICO 10T models to help determine a borrower's creditworthiness. VantageScore 4.0 and FICO 10T use so-called "trended" credit data, reviewing a borrower's credit management over a period as long as two years. Classic FICO and the other models above employ a more recent "snapshot" arrangement, where just a few recent months of credit activity are used to help determine a borrower's credit score. This means that potential homebuyers who want to get the lowest possible mortgage rates need to better manage their credit over a longer period of time. However, these new "trended credit" models also allow for the inclusion of additional credit sources such as rent, utility and communications accounts (where available) to be included in the borrower's score.

Since allowing these changes means underwriting software across the entire mortgage origination spectrum will need to be updated, "FHFA expects that implementation of FICO 10T and VantageScore 4.0 will be a multiyear effort." Since lenders will adopt this new opportunity at differing speeds, borrowers with more marginal credit should shop for a lender who is already employing these new models, as it may improve their chances of qualifying or getting a lower mortgage rate.

The problem with other available scores consumers might buy or access, says Madison, is that borrowers are set up for false expectations.

"They may either be expecting to qualify for a better mortgage rate than they do, or they may lose out on opportunities for which they don't believe they will qualify, when, in reality, they can," says Madison. This is why having alternative sources of credit -- that can help prove your ability to repay a loan -- is important.

Establishing credit

Ross says it takes just six months of credit card usage to generate a credit score, but lenders would also need other sources of credit in addition to your six-month-old score.

"Using alternative credit doesn't change someone's credit score, so if your score is low, all you can do is let time pass while you do the right thing over and over again," says Madison.

It's especially important that prospective buyers with thin credit consult with a mortgage lender, says Ross. They can provide you with "a road map to follow to improve your chances of qualifying for a mortgage."

This article was updated by Keith Gumbinger.