Before the recession, average FICO scores for approved mortgages averaged around 720. 720 is actually the cut-off point between “Good” and “Excellent” credit. Given the housing market collapsed nationwide anyway, one shouldn’t be too impressed with a 720 credit score. A 720 credit score should be viewed as average, at least from this loan officer’s perspective.
After the housing bubble burst, the average score for approved mortgage applicants shot up to 769 from 2009 until the end of 2012. A 769 credit score beats out 80% of all other credit scores out of 850. In other words, banks weren’t lending to hardly anybody. The upside is that the probability of a similar type of housing crash in the future has declined.
The “good news” for borrowers is that according to Fannie Mae the average credit score of an approved mortgage applicant is now down to 741 as of the third quarter of 2016. I say “good news” because it’s brutal for even good income earners to get a mortgage nowadays. Many renters I know have been shut out of the housing market simply because they can’t get a loan.
Although credit standards are loosening, a credit score of 741 is still a pretty high hurdle to overcome given you still need a good income and a healthy balance sheet to cover borrowing ratios. But at the margin, a lower credit score hurdle should allow more people to borrow money to further support the housing market recovery. I still see little signs of sub-prime mortgages or negative amortization mortgages returning. But one thing we should be concerned with is the latest Federal Housing Administration initiative to get Boomerang Buyers back in.
BOOMERANG BUYERS RISE UP
The Federal Housing Administration has come out with a new program allowing buyers who lost their home to a foreclosure or short-sale to buy another home. These buyers are dubbed “Boomerang Buyers” because they’ve come back for more.
The program requires that applicants show they lost at least 20 percent of their income for at least six months, which in turn caused them to lose their home. Boomerang Buyers then must show they recovered from hardship (grey area) and have had clean credit for at least one year. Clean credit doesn’t mean a good credit score mind you. Once borrowers pass the initial tests, they are eligible for regular FHA loans which require just a 3.5 percent down payment – no different from a first time FHA loan applicant who never foreclosed or short-sold a home!
Think about this for a little bit. The government, in all its wisdom is allowing those who stopped paying their mortgage for whatever reason to try again with only 3.5% down. Meanwhile, banks who are offering jumbo mortgages (not covered by Fannie or Freddie) are requiring 20% or greater down with ~741 credit scores to buy a home. This is the main reason why jumbo loans have LOWER rates than conforming loans. The borrowers are simply higher quality.
One would think that going through the trauma of foreclosure or a short-sale would produce home-buying scars for at least a decade (takes ~7 years for your credit score to fully recover). One would also think that if you foreclosed on a home before, you should at least be required to put down greater than 3.5%. But I guess the government is so pro-homeownership that they can’t help but get people who can’t afford a home to try again.
If you only put 3.5% down, you hardly have any skin in the game. The first people to foreclose again during the next downturn are those with the least amount down. To make a point, if you paid 100% cash for your house, of course you aren’t going to foreclose given the cost of ownership is minimal. It would be better for all of our finances to follow the 30/3 rule for home buying.
THE MARKET IS STILL TIGHT
If you are long the property market, you are relatively sanguine about the current loosening of credit standards. One property I own in Tahoe tanked because nobody could get a condotel mortgage anymore. This was despite the property yielding a net operating profit yield of 8-10%. The only buyers were cash buyers. Things have recovered like everything else, but the mortgage market for condotels is still tight.
If you are short the property market (renter), then you should either take full advantage of an FHA loan or overweight mass market homebuilder stocks until they blow up. Just like how it’s unwise to fight the Federal Reserve when investing in the stock market, it’s unwise to fight the Federal Government when investing in the real estate market. The Federal Government is signaling they will do everything in their power to get as many Americans to own a home as possible, regardless of their history.
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Updated for 2020 and beyond.