Low credit scores are a harbinger for future home purchases

Credit scores for homebuyers using purchase-assist financing have declined for the sixth straight month since May, according to Ellie Mae’s latest Origination Insight Report (OIR).

Ellie Mae is a software company that processes nearly a quarter of mortgage applications nationally. Ellie Mae’s OIR is based on data collected from closed and denied applications for conventional mortgages and mortgages issued or insured by:

  • the Federal Housing Administration (FHA); and
  • the Department of Veterans Affairs (VA).

Data collected from each mortgage application include the applicant’s:

  • FICO score;
  • loan-to-value ratio (LTV); and
  • debt-to-income ratio (DTI).

The OIR released by Ellie Mae for November 2015 reveals yet another drop in FICO scores, with the average score of 721 – down from 722 in October and 730 in May 2015.

What low credit scores mean for home sales

Lower credit scores may not seem like an issue just yet. However, the Federal Reserve (the Fed)’s recent interest rate increase suggests credit scores will become increasingly more critical in the coming years as the economy normalizes in its current expansion.

Buyers with low credit scores are required by lenders to accept higher interest rates on their mortgages to compensate for the lender’s increased risk of default, and thus loss. Compound the higher rates required for mortgage qualification with the bond market’s eventual mortgage rate increases, and homeownership becomes a lofty dream out of reach for many potential buyers.

The effects of the rate increase aren’t expected to manifest for fixed rate mortgages (FRM) until at least mid-2016, and the immediate effect on adjustable rate mortgages (ARM) is minor. However, increased interest rates will eventually cause those with low credit scores who do manage to obtain financing to facedoubly-increased interest rates. This dual punch is a hard hit to buyers whose lack of personal savings and stagnant incomes (which likely brought on the low credit scores) previously benefitted from the zero lower-bound rates of the past six years.

These cumulative, restrictive conditions make it more difficult for buyers with low credit scores to meet the requirements for a qualified mortgage (QM). Thus, these conditions will reduce the amount of money they can borrow, or worse, lock potential buyers out of the market. As a result, this will exert downward pressure on home prices.

Additionally, mortgage lenders are of no help in resolving the worsening conditions. They harbor a universal contempt for the regulations that restored fundamental loan documentation and qualification rules to the practice of originating consumer mortgages. Lenders will not be happy until they have proven by their resistance that these regulations are killing the real estate market.

To reiterate, buyers’ present difficulties making a traditional 20% down paymentand increasing their personal savings is to kick a long-dead, possibly now-skeletal horse. However, these factors continue to affect results in the real estate industry – especially since they contribute to the delayed entrance into homeownership by members of Generation Y (Gen Y) and other struggling first-time buyers who otherwise boost the market in normal economic times.

Re: Origination Insight Report, November 2015 from Ellie Mae