Our home-builder clients sell hundreds of homes every weekend to buyers with 5% down payments and below average credit scores. Yet, many middle-income households with average credit and access to a 5% down payment assume they cannot become homeowners because of the “tight credit” headlines.
Renters can become homeowners today if they have the following:
- A credit score in the top-60th percentile (or even lower) of Americans
- Three years of evidence of their income
- The willingness to pay up to 42% or even more of their income for housing
- A 5% down payment, especially if buying a home priced less than 15% above the median home price in a metropolitan area
We are not experts on what credit policy should be, nor advocates of whether credit should be tighter or looser. Our role is to educate business people on market conditions. We believe that mortgages are more attainable than many think.
The Tight Credit Conversation
Long-time lenders know that there are 4 Cs to good lending: credit, character, capacity and collateral. Two of the Cs appear tight, while the other two appear quite loose.
The financial press (who are generally focused on the biggest banks in the country and who also live in some of the most expensive markets in the country), real estate lobbying organizations (who always lobby for looser lending), and affordable housing advocates (ditto) loudly proclaim that mortgage credit is far too tight. They are focused on two of the Cs:
- Credit: The lower-than-usual levels of lending to borrowers in the bottom-40th percentile of credit scores
- Character: Lending to those who cannot produce documentation of steady income
The charts below support their claim but do not support the notion that mortgage credit is unavailable to most Americans.
Affluent executives, especially in the expensive markets, also buy into the tight credit argument because they have heard how difficult the documentation is and that high LTV loans to jumbo borrowers are hard to obtain. They are correct. Documentation is tight, and jumbo borrowers need excellent credit or a large down payment. However, most entry-level home buyers who are buying a median-priced home somewhere in the middle or south of the country do not need a jumbo mortgage.
The Home Buyers Conversation
Most home buyers pass the credit and character test mentioned above, although clearly not as many as could pass the tests in 2000. A near historical number of home buyers today also pass the other two tests:
- Capacity: Banks are lending quite freely to borrowers willing to pay more than 42% of their gross income on housing (known as debt-to-income ratio or DTI). In fact, 35% of primary home buyers obtaining a mortgage guaranteed by a government agency2 (which account for 85% of all purchase mortgages) pay at least 42% of their income for housing—the threshold Dodd-Frank suggested as a maximum.
- Collateral: An all-time high number of primary home buyers with a mortgage guaranteed by a government agency2 (57%) are putting down 10% or less. The fact that renters have been unable to save a 5%–10% down payment is another issue that confuses the credit discussion. Many assume that a 20% down payment is required for most homes, which is not the case.
Banks, and a growing number of nonbanks, make these high DTI and LTV loans because they are purchased and/or guaranteed by government agencies2. Home builders know exactly how to direct home buyers into the best mortgage program for them.
The charts below, using data provided by the American Enterprise Institute, show the statistics on all four credit metrics, with the light blue dot representing today and the column representing the early 1990s at the bottom, the early 2000s in the middle, and the height of subprime lending at the top.
A growing number of banks are expanding the credit box, especially to include more low-credit borrowers. Here is a table showing some of the most recent low down payment products by lender:
Fannie Mae and Freddie Mac are also trying innovative ways to loosen mortgage credit in the two tight Cs: credit and character. Last month, Freddie Mac along with two nonbank lenders announced a new pilot program aimed at loosening income and documentation standards for first time to low- to moderate-income applicants. The pilot program is taking place in Las Vegas, Nevada, and Tustin, California, where the two mortgage originators are located.
Fannie Mae is also allowing the use of trended credit data into its automated underwriting system in an effort to allow borrowers to demonstrate how they have managed their revolving credit card debt in the past 24 months. This new information could potentially increase access to mortgage loans.
In summary, mortgages are more available than many believe and are becoming more available every day. While documentation remains intense, and some lower-credit borrowers remain more challenged than some groups would like, Americans with 5%+ saved for a down payment and documentable income can qualify for a mortgage payment equal to 42%+/- of their income. I wonder how many more homes would be sold if this were widely known.
1Refers to the government-sponsored enterprises Fannie Mae and Freddie Mac
2Includes Fannie Mae, Freddie Mac, FHA, VA, RHS