Why It’s Now Harder to Get a Mortgage With a Small Down Payment

If you’re a first-time homebuyer with a low down payment and high debt, you’re going to have a harder time getting a mortgage this spring, due to new credit standards from private mortgage insurers.

Starting in March, borrowers whose debt payments—including their mortgage and other credit—will exceed 45% of their monthly gross income won’t qualify for private mortgage insurance (PMI) from MGIC, Essent or National MI unless they have a 700 FICO score or higher. PMI is required on fixed- and adjustable-rate mortgages backed by Fannie Mae if the down payment is less than 20%.

Together, these requirements create a triple whammy for some first-time homebuyers who often have smaller down payments, higher debt obligations—such as student loans—and traditionally lower credit scores than more seasoned buyers.

The moves come less than year after Fannie loosened its own requirements by considering borrowers with a 620 credit score and debts up to 50% of income. The ceiling was 45% before. Fannie has been looking at other ways to expand access to mortgages, such as considering newer credit scores that are more forgiving.

Here’s what to know about PMI changes and how to respond.

Why the change?

The PMI companies noted an uptick in mortgage borrowers with debt-to-income above 45% along with other credit risks in the latter half of 2017. That was worrying to insurers.

“Our concern is that we have seen loans with these characteristics have anywhere between 30-50% higher probability of default,” MGIC spokesman Mike Zimmerman said in an email to ValuePenguin. He wouldn’t cite current delinquency figures for these loans that make up 1-2% of the company’s overall portfolio, but said that, overall, all mortgages are performing well.

The concern is largely what could happen down the road. “We have seen loans that have multiple risk factors [such as high DTI] perform worse when a household experiences a hardship,” Zimmerman wrote in a follow-up email. “Sometimes the hardships are self-inflicted, meaning bad credit management, and sometimes they are a result of economic downturns.”

Who does it affect?

The Urban Institute estimated 95,000 more loans would be approved each year, thanks to Fannie’s debt-to-income change last year. But now those same mortgages may not be approved because so many PMI companies won’t insure them, a Fannie requirement.

These loans would largely go to first-time homebuyers who are more likely to put less than 20% toward the purchase of a home than move-up buyers. Two-thirds of first-time homebuyers last year put down 10% or less, according to the National Association of Realtors. The Urban Institute also estimated that black and Hispanic homebuyers would disproportionately be affected by the DTI requirements.

Find out where you stand

If you have less than a 20% down payment for the purchase of a home, it’s good to know what the rest of your credit profile looks like, especially as qualifications standards change.

Find out your credit score: It’s important to know if you’re near the 700 FICO score threshold that private mortgage insurers have established. There are several ways to get your FICO credit score for free. Discover and FreeCreditScore—owned by Experian—provide free FICO scores when you sign up. Some banks and credit card issuers also offer a FICO credit score at no cost on a monthly or quarterly basis for their customers.

Know your DTI: Add the minimum monthly payments on your credit cards, car loans, student loans and other credit obligations to your estimated mortgage payment to get your total debt figure. Next, determine your monthly gross income by dividing your pre-tax salary by 12. Now, divide your debt by income. If that number is over 45%, you may have trouble getting a Fannie-backed mortgage.

What you can do

If you’re on the cusp of qualifying for a Fannie mortgage because of the new DTI requirements, don’t despair. Your homebuying dreams aren’t dashed yet. Consider these alternatives.

Pay off debt: It’s obvious: To lower your DTI, eliminate balances you owe. But, the way to reduce your DTI in a hurry can often fly in the face of conventional personal finance advice, which typically calls for paying down debt with the highest interest rates first. Instead, in this case, “it’s all about the minimum payment,” says Scott Sheldon, branch manager of New American Funding in California. “Pay off the obligations that have the highest monthly payment with the lowest balance [to] get the biggest bang for the buck.”

Because DTI looks at your monthly obligations—rather your debts as a whole—getting rid of a $300 monthly payment at 0% APR will help you qualify quicker than if you paid off a debt with a $200 payment at 6%.

Set your sights lower: Another way to decrease your DTI is to reduce the monthly payment for your hypothetical mortgage. There are two ways to do that: Increase your down payment or get a lower priced home that requires a smaller mortgage.

Other mortgages: Home loans backed by the Veterans Administration and the Federal Housing Administration both have looser credit requirements, including low to no down payment requirements and DTI up to 54.9%. There are other costs to consider before committing. Find a loan officer who can walk you through your options.

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