Are we going back to the future? It was announced this week that a major lender will immediately begin underwriting FHA & VA loans with a minimum 550 credit score. This is a sizable leap from the existing FHA floor, as most lenders expect a minimum credit score of either 620 or 640. There are updated requirements and provisions to underwrite these loans in order to prevent excessive default, but this change has created shock-waves throughout the mortgage and real estate industries. Is this a possible sign of things to come or is this just the act of one rogue lender looking to drum up new business any way possible?
According to Carrington Mortgage Services, LLC, the thought process in making this change is to cater to the tremendously under-served buyer market. One in three buyers have a credit score under 650, with another large segment residing under 600. Their thinking is that this may not be a sign of irresponsible repayment practices, but instead the act of one or two smaller credit cards impacting their total financial picture. If they can capture a bigger share of the buyers’ market, they feel the risk may be worth the reward.
The thought among skeptics is that this could lead the next wave of irresponsible lending. The major difference between these loans and the ones that destroyed the industry some six years ago is in documenting the income. All of the income must be documented with strict debt to income ratio guidelines in place. They are not simply approving any loan application that comes across their desk. The income and the loan must make sense with adequate reserves and other factors in place. They are viewing the underwriting process with these loans as the big picture and seeing if the loan makes sense.
The biggest reason for this move by Carrington is to combat the millions of dollars of lost revenue in the shrinking refinance market. With interest rates as low as they have been for the past few years, many homeowners who could refinance already did. Now that rates have begun to creep up, the refinance pool is getting smaller and smaller and will eventually represent only a small portion of a lenders business. With so much competition for the small pool of buyers, they are taking a chance with borrowers with lower credit scores. Time will tell if the default rates will be through the roof and this decision backfires, but for now they are banking on an immediate spike in applications.
Like most things in business, if something works, the competition will copy it. Carrington has made the first move and it is a bold one. If it works, you can expect Wells Fargo, Bank of America and the other big boys to quickly follow suit. They are not going to sit by and watch their market share shrink without taking action. All of this sounds eerily familiar to what happened with the vast array of stated income and low down payment programs that became the rage last decade. Time will tell if these changes and new programs are a passing fad or a sign of things to come.