Two major lending changes that took effect in July will loosen up mortgage credit for millions more Americans – and the timing couldn’t be better for mortgage lenders, which are fiercely competing for declining volume.
As of July 1, the three major credit rating agencies – Equifax, TransUnion and Experian – started eliminating tax liens and civil judgments from some consumers‘ credit reports when the information was incomplete. For example, if the borrower’s Social Security number is not included with the tax lien or judgment information, it won’t be included in the credit report.
In addition, government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac have increased the standard pre-tax debt-to-income (DTI) ratio for most borrowers from 45% to 50%, thus allowing borrowers to hold higher levels of debt and still qualify for a mortgage. The GSEs say they are making this change in an effort to help out millennials who hold large amounts of student loan debt.
Although these changes could help millions more borrowers qualify for a mortgage, they also have sparked concerns that they will increase risk in the mortgage market.
The main risk with eliminating lien and judgment information, mortgage experts say, is that it might result in some borrowers getting credit when it shouldn’t be extended to them. In other words, it will open up credit to consumers who normally wouldn’t be able to get it due to liens and judgments.
According to Fair Isaac Corp. (FICO), about 7% of the approximately 20 million Americans with a credit profile have liens or civil judgments against them. By eliminating these hits to their credit, their scores could go up by as much as 20 points, the organization says.
But as Ann Fulmer wrote in a recent article on MortgageOrb, lenders do have other options for getting lien and judgment information – so, just because the credit agencies are eliminating the information doesn’t mean lenders have no way of finding out if it exists. It just means they will have to go to other sources.
Some experts are similarly concerned that Fannie’s and Freddie’s move to loosen up the DTI requirement could also increase risk for the market. However, in a recent CNBC report, Doug Duncan, Fannie Mae’s chief economist, said the degree of risk associated with loosening DTI is minimal.
“In this case, we’re changing the underwriting criteria, and we think the additional increment of risk for making that change is very small,” Duncan told CNBC’s Diana Olick in the July report. “Given how pristine credit has been post-crisis, we don’t feel that is an unreasonable risk to take.”
Furthermore, just because Fannie and Freddie are lowering the DTI requirement doesn’t mean they can’t tighten credit in another area in order to keep overall risk at current levels.
One should view these changes not just as a move to increase the availability of credit, but also as part of an overall initiative on the part of the industry to start using different sources of data for underwriting. Basically, the information that’s being used to assess creditworthiness is changing – and a secondary effect of that, whether just perceived, is a loosening of credit.
With the desperate need to get the mortgage market moving again, such measures could be well worth the risk.