Editor's note: This feature originally appeared in the November issue of MReport, click here to access.
Getting a mortgage with a super-prime credit score is easy—and, if today’s low interest rates are any indication, it’s a good idea. However, borrowers with lower credit scores face significant challenges.
According to recent research by Experian, 22 percent of borrowers in the U.S. qualify for the super-prime group with a score above 740. Below them, 36 percent fall into the good-to-prime category—while these are decent scores, they are nothing for lenders to get excited about. Everyone below that—those with a score of 659 or lower—encounters steep obstacles during the mortgage-application process.
Lenders check applicant credit scores before they check anything else. As lending rules remain tight after the crash of the late 2000s, risk assessments place many would-be borrowers with bad scores in tight spots. Banks either offer them no options at all or options with outrageous terms, preventing applicants from taking advantage of a good economic climate.
“The regulatory atmosphere changed from a risk-management regime to a zero-tolerance and 100 percent-compliance regime,” Meg Burns told the Wall Street Journal. “In the face of stiff penalties and aggressive scrutiny, banks were left with a tremendous uncertainty and risk that made it hard to keep lending.”
Brokers shouldn’t give out loans to anyone who asks, but people with suboptimal credit scores still have money to spend—and they have to live somewhere. Rather than slam the door on more than half of American borrowers, mortgage brokers should diversify their portfolios to offer reasonable loans to qualified buyers in all credit ranges.
Changing the Broker Mindset
Brokers need to be impartial in their lending decisions—that’s not necessarily a bad thing; however, brokers who put people who are already in tight financial spots into even worse scenarios set them up to fail. That’s bad for business.
Borrowers who are maxed out on their budgets cannot afford to take on big upfront costs, yet brokers continue to shoehorn low-score applicants into bad options. Why set up low-score applicants to fail with a short-term plan that will drain their nances and create headaches for our side of the deal? It doesn’t make sense—yet many brokers continue to do just that.
If brokers want to service borrowers with lower credit scores, they cannot continue to squeeze applicants into six- to nine-month plans that don’t. Regulations might prevent brokers from offering the world, but brokers can still deliver a diverse range of reasonable options without breaking the rules or making bad business decisions.
Offering a Range of Better Choices
Buyers with low scores should not be limited to strict loans with high upfront costs and exorbitant interest rates. These deals only provide a bit of short-term revenue for lenders and lead to massive hassles when borrowers inevitably fail to make their payments. More often than not, borrowers with low credit scores are strapped for cash.
And the upfront costs of homeownership present a steep barrier to entry. Interest rates are low, but home prices are high. Brokers who demand 10 or 20 percent down payments (plus closing costs) lock out applicants who would be excellent borrowers. True, traditional loans require that level of initial investment, but that doesn’t mean borrowers should have no other alternatives.
Brokers should offer a wide variety of choices to people who reside on the bottom half of the credit spectrum. For example, homebuyer-assistance programs exist for organizations ranging from unions to veterans’ groups to local governments. These programs can mitigate many of the upfront costs of loans, sometimes rolling the costs into the payments, to make the process easier on buyers with low credit scores who are strapped for cash.
Many low-credit buyers are not aware of all their options. But neither should they be expected to. Brokers, as the middlemen between lenders and applicants, should help these prospective borrowers identify the homebuying product or partnership that works best for their unique scenario.
“Prospective first-time buyers often think the loan process is too hard and that the closing costs are too substantial,” said Ray Brousseau, EVP of Carrington Mortgage Services, to the Washington Post. “They don’t realize that there are programs for them that allow for a limited down payment and eliminate other out-of-pocket expenses, including closing costs.”
Mortgage brokers know what mortgage applicants do not. The path toward homeownership is not a single road but a wide range of curving streets that all lead toward a common goal. Brokers who deny certain applicants the chance to take the path that’s right for them not only deny those applicants the opportunity to own a home—they also deny that income to the lenders behind the loans.
Giving Borrowers a Chance to Make the Cut
Brokers also have another option to help low-credit applicants secure a mortgage. If applicants still don’t qualify for the new options brokers present, then a secondary service could be offered, which would focus on helping potential borrowers understand how to increase their credit scores.
While credit scores might seem like a straightforward science, this isn’t always the case for prospective borrowers. For those who don’t work in the mortgage industry, credit scores are a dif cult concept to understand—even for the most educated people. Most people know they should make payments on time, but outside of that, they don’t understand what helps and hurts their credit scores. While brokers know, the general population is unaware.
And prospective buyers don’t expect their mortgage broker to educate them on the ins and outs of building a good credit score. Moreover, low-credit applicants don’t think brokers will provide them with a solid plan to improve their credit scores, thereby increasing their chances of securing a mortgage the next time around. However, if brokers take the extra step to educate their clients about credit scores, then they could earn a loyal, lifelong client. A potential borrower would be much less likely to walk away from a broker who not only diversified their portfolio but also provided resources to help them qualify for those new options in the future.
Here are a few strategies that brokers can give potential borrowers to help them increase their credit scores and qualify for one of the mortgage products being offered:
- Seek a Free Credit Report. Multiple companies offer a free credit report. Credit Karma is a great place to start, especially if borrowers are beginning to learn about credit scores. However, if applicants want something more insightful, then brokers should send them to AnnualCreditReport.com. This website enables aspiring homeowners to download a free yearly credit report, which shows the same information that brokers see and also reveals insight borrowers never knew existed.
- Dismiss Any False Items. Credit reports are not always accurate. Sometimes they include mistakes, which is why brokers should tell low-credit applicants to carefully review their credit reports to figure out what should and shouldn’t be on it. More often than not, people with common names will notice errors. For example, loans, accounts in collections, and even credit cards could be attributed to the wrong identity. If a prospective borrower notices a mistake on his or her credit report, he or she should go on Credit Karma to file a dispute. This dispute will also be led with Equifax, Experian, and TransUnion. However, if the dispute doesn’t work, the next step is for mortgage applicants to send a certified letter asking the company who serviced the loan to verify the debt.
- Develop a Plan of Action. After mistakes are removed, and accounts are verified, borrowers are ready to develop a plan of action to increase their credit scores. This is not a short process; usually, it takes a couple of years for people to see significant changes. But the length of time it takes doesn’t mean it’s not worth putting in the work. Potential homeowners should still develop a plan that addresses all the relevant factors that go into building a good credit score.
If an applicant has a history of missing payments, for example, brokers should tell him or her to set up alerts so he or she doesn’t make the same mistake in the future. Moreover, if prospective borrowers want to minimize their debt, brokers can suggest paying down their credit cards until the amount owed is less than 10 percent of their available credit.
Additionally, brokers should tell low-credit mortgage applicants to avoid closing their oldest credit cards if possible. While credit age isn’t the most important factor in building a good credit score, it still matters. But on the flip side, borrowers shouldn’t open too many credit cards—hard pulls cause small dips in credit scores.
These tips won’t help borrowers get approved for a mortgage tomorrow or even in a couple of months. However, that doesn’t mean brokers shouldn’t take the time to educate applicants on how to build a good credit score. The strategies brokers offer can pay off in the long run when prospective homeowners apply for a mortgage after seeing their credit scores increase.
Today, brokers should not turn away people with good income-to-debt ratios merely because they don’t have perfect credit histories. By offering a wider range of lending options and tips to qualify for those options, brokers can put more deserving borrowers in good homes, without forcing those borrowers into deals they won’t be able to uphold.