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‘No Credit? No Problem!’
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By some estimates, 50 million people lack traditionally established credit — but still have track records in paying regular bills such as rent, utilities, insurance, and telecommunications. The absence of a credit history shouldn’t be seen as an insurmountable barrier when considering whether to underwrite a mortgage. After all, many people prefer to pay as they go to avoid debt.
The Federal Housing Administration (FHA) and conventional secondary market programs offer ways to establish a borrower’s creditworthiness other than the traditional approach of relying on use of credit cards, installment loans, mortgages, and similar borrowing methods. Alternative approaches can help borrowers who might otherwise get shut out of the prime market — and the lenders who might not otherwise reach them.
Traditionally, credit history looks at the number of trade lines a consumer has opened and his or her payment history. To generate a traditional credit score, a borrower must have one trade line that is at least six months old, with a balance on it. Fair Isaac Credit Services, Inc. estimates that 50 million U.S. consumers have credit histories that can’t clear that hurdle. These nontraditional borrowers are disproportionately Hispanic (24 percent), African-American (14.6 percent), and recent immigrants.
“A lack of traditional credit is one of the largest barriers to Hispanic homeownership,” says Gary Acosta, chief executive officer of Prado Mortgage and chairman of the National Association of Hispanic Real Estate Professionals.
Although many people now renting do not have traditional credit histories or scores, they do want to become homeowners. Fannie Mae estimates that 5 million renters without credit scores can afford to purchase a home. And about 500,000 new homebuyers without traditional credit scores complete a home purchase through FHA or the subprime market each year. By taking advantage of nontraditional credit history programs now offered in the secondary mortgage market, lenders can avoid needlessly relegating would-be borrowers to the subprime or “Alt A” market.
Fannie Mae, Freddie Mac, and FHA each have established guidelines that lenders must follow when underwriting a loan for a borrower without a traditional credit score or history.
FHA allows a lender to develop its own Non-Traditional Mortgage Credit Report (NTMCR) or to use a credit reporting agency to document the borrower’s payment history. A NTMCR, however, may not be used to enhance the credit history of a borrower with a poor payment record or traditional credit score or to “manufacture” a credit report for someone without a verifiable credit history. In creating an NTMCR, lenders may use several types of credit that require the borrower to make periodic payments on a regular basis, such as rental housing and utilities that are paid at least every three months. In some cases, a record of voluntary periodic payments — such as savings deposits — may also help qualify the borrower. FHA’s guidelines may be found in chapter 2 of HUD Manual 4155.1 REV-5: Mortgage Credit Analysis for Mortgage Insurance, One- to Four-Family Properties.
“Alternative approaches to determining creditworthiness can help borrowers who might otherwise get shut out of the prime market — and the lenders who might not otherwise reach them.” |
Fannie Mae allows lenders to use NTMCRs only when a traditional credit score is unavailable for the borrower from any of the three major credit repositories. Fannie Mae then segregates the borrower’s periodic payments into one of three tiers. Tier I credit includes rent, utilities, and telecom payments. Tier II payments are those the borrower paid directly to insurers (rather than through payroll deduction) for automobile, life, household, or renter’s insurance. Tier III credit includes payments to local stores, payments for durable goods such as automobiles, medical bill payments and payments for school tuition, childcare, or personal loans (documented by a written loan agreement and canceled checks).
In establishing the borrower’s credit history, the lender must start with tier I creditors. The goal is to obtain a 12-month history from four sources. If the lender cannot retrieve information from four tier I sources, it must then check tier II and eventually tier III to develop a history that includes four to six sources of positive or negative history. Fannie Mae’s guidelines may be found in the Fannie Mae Selling Guide, Part X (Underwriting Guidelines), sections 103 and 804.
To create an NTMCR, Freddie Mac lenders must directly verify timely payments of a mandatory nature, including rent, utilities, or union dues using canceled checks, receipts, or written verification from a professional property manager. Freddie Mac also allows lenders to consider regular payments of a voluntary nature, such as savings deposits or contributions to a payroll savings plan or stock purchase plan. A documented savings history of 12 months’ duration, with deposits made at least quarterly that result in a growing balance over the year, can be counted as a trade line. To establish an acceptable credit history, a borrower would need three trade lines or four noncredit payment references seasoned 12 months. If the borrower has both trade lines and noncredit payment references, then a total of four regular payments are required. Freddie Mac’s guidelines may be found in the Freddie Mac Single-Family Seller/Servicer Guide, volume 1, chapters 37.4 and 37.11.
It seems clear that careful and appropriate use of NTMCRs can help reduce obstacles for consumers who might otherwise be subjected to unnecessary subprime mortgage rates or even be rejected entirely for financing. In short, taking the nontraditional route — “the road less taken” — can be a good way for lenders to help borrowers move into the mainstream of homeownership financing.
