Talk to anyone with a few years’ experience in the mortgage business and they will tell you that mortgage guidelines change from time to time.
What Are Mortgage Guidelines?
Fannie Mae and Freddie Mac are the largest, most well-known mortgage aggregators. Fannie and Freddie do not lend out money for mortgages, but they do set the guidelines. In layman’s terms, Fannie Mae and Freddie Mac are a go-between of the borrowers, banks or mortgage lenders, and mortgage-backed security investors.
Doesn’t The Mortgage Money Come From The Banks and Mortgage Lenders?
A common misconception is that mortgage money comes directly from the originating bank or mortgage lender. In reality – a mortgage is obtained by Bank A. In that case, Bank A does not go into its vault and pull out money. Bank A, originates a conventional conforming mortgage and goes through Fannie or Freddie to connect with investors.
Fannie Mae or Freddie Mac with then take that mortgage (along with many others) and package them together to sell to investors. These investors who purchase mortgage-backed securities earn interest on their investments. Since these mortgages are backed by Fannie and Freddie – the investors feel confident in these investments.
Where Do Guidelines Come In?
Fannie Mae and Freddie Mac set a standardized list of guidelines that they follow to back mortgages. These guidelines set rules for minimum credit score and maximum debt-to-income ratio. In addition, they set a standard guideline for reviewing income and asset guidelines among other things.
With a standard set of guidelines for all mortgages, investors in mortgage back securities feel confident to continue investing. The mortgage market functions properly when borrowers, banks, and investors all work in conjunction, the mortgage market functions properly.
Are There Variations To These Guidelines?
To sell conventional, conforming mortgages through Fannie or Freddie banks and mortgage lenders are required to follow the guidelines. Mortgage companies can choose to impose stricter guidelines, but cannot go the other way and loosen guidelines.
A great way to think about this relationship is similar to the federal government and state governments. An individual state can pass a law that supersedes a federal law. When that happens, the state law only applies within the particular state borders. That state law would not apply to citizens of the state when they are in another state.
A good example of this is the minimum credit score in the mortgage world. Currently, on a conventional mortgage, the minimum credit score is 620. Although Fannie and Freddie will work with mortgages with a credit score down to 620 some mortgage companies choose to require a 640 score. Mortgage companies can do this as long as it is applied across the board.
So 620 Is The Minimum Credit Score – No Option To Go Below That Number?
Technically, 620 is the minimum credit score required – but recently Fannie Mae changed how they determine a credit score. For all mortgages, a full residential credit report is required. The full residential credit report is a hard pull from all three credit agencies. The three credit agencies are Equifax, Experian, and TransUnion.
When there are two borrowers on a mortgage, historically Fannie Mae would take the lower of each borrower’s middle score. For example”
Borrower 1
Equifax 722
Experian 707
TransUnion 741
Borrower 2
Equifax 697
Experian 703
TransUnion 685
In this case, the middle scores are 722 and 697. For pricing and approval, the lender would use 697.
With this structure in place, there have long been questions regarding why is the lower score used. While lenders then to be conservative and made the assumption the client with the lower score impacts the client with the higher score. Consumer advocate groups would argue that one client with a higher score will positively impact the lower score. In this case, mortgage payments are made on time, and in the long run both client’s scores improve.
What Recently Changed?
One of Fannie Mae and Freddie Mac’s implicit goals is to promote homeownership. To help this cause, Fannie Mae has recently made a change that will take an average of all borrower’s middle scores. To be eligible for this program the lower middle score must be 580 or higher.
Instituting this new policy will help clients who may have a lower credit score due to limited credit history. This program can also help clients who had credit issues in the past but are now working hard to rebuild their credit.
How Is The Score Determined?
Let’s look at an example:
Borrower 1
Equifax 670
Experian 690
TransUnion 672
Borrower 2
Equifax 633
Experian 605
TransUnion 596
The middle scores are 672 and 596. Under the old system, the score used for consideration would be 596. These clients would not qualify for a conventional, conforming mortgage. Now under Fannie Mae’s new guideline, the credit score calculation is:
596 + 672 = 1,268 / 2 = 634
With a score of 634, these clients are now above the 620 minimum credit score and can qualify for a conventional mortgage.
This great change will help many clients, who were previously shutout, out qualify for a conventional mortgage. Not all lenders are using the average credit score. Some have an overlay and still require a 620 from all borrowers. If you have questions about this program you can dm me or reach out to your mortgage broker.