The federal government has made borrowing money easier for homebuyers with less traditional housing situations and lower incomes while making it more difficult for buyers with burdensome student loan and other debt to get mortgages. The changes are intended to reflect the realities today’s new borrowers face.
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In December Fannie Mae, the quasi-government mortgage finance giant, launched HomeReady, a new mortgage designed for low- to moderate-income borrowers with nontraditional sources of income. For example, HomeReady lets applicants report rent from a roommate or tenant as income.
Borrowers can now count money provided by parents as income in applying for mortgages. Down payment money that doesn’t come from a gift generally must be reflected in the borrower’s two most recent account statements.
Among the requirements: The property must be in a lower-income neighborhood, or in some locations the borrower’s income must be no higher than the area median income (AMI). In other locations, the borrower’s income can’t exceed 80 percent of AMI. Fannie Mae says its fees for the loan are likely to be the same or possibly lower than market rates, though a lender might charge interest slightly higher than market rates to account for the lending risk.
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Meanwhile, the Federal Housing Administration, a major insurer of mortgages to lower-income buyers, has tightened loan standards for its popular FHA-insured mortgage. Among the new rules: Two percent of a borrower’s deferred student debt—loans that are currently not in repayment—must be included in her debt-to-income ratio (DTI), an important figure used to judge mortgage applicants. Lenders usually want borrowers’ debt, including education, auto, home, and other, to be no more than 43 percent of gross income. The rule is intended to ensure that a homeowner can afford mortgage payments once the student debt is no longer deferred.
Take a mortgage-seeker earning, say, $40,000 per year, or $3,333 monthly. With a debt-to-income ratio of 43 percent, that borrower could afford $1,433 per month in total debt payments. Under the new rules, if the mortgage applicant also had a student-debt load after college of say, $27,000, she’d have to subtract 2 percent of that amount, or $540, from that $1,433 per month. That would leave $893 per month to cover all debt payments, including the mortgage. On the other hand, the FHA has reduced the premium it charges on the mortgage insurance it provides—a boon to borrowers.
Dean Wegner, sales manager for Academy Mortgage in Scottsdale, Ariz., says the FHA loan is useful for those recovering from financial straits. “A key advantage is the waiting periods after a significant credit event,” he says. For example, the FHA will consider insuring a borrower three years after a short sale; in contrast, that borrower might have to wait up to four years for a HomeReady mortgage.
How to Improve Your Chances
Wegner advises his first-time borrowers to buff up their credit score, which is based on credit history, before seeking a loan of any kind. A credit score of 680 will get you a decent mortgage rate, but for the best mortgage rate you’ll need 740 or better.
To raise your credit score, pay bills on time and keep low balances on credit cards. Regularly check credit reports from the three credit-reporting bureaus—Equifax, Experian, and TransUnion. Get errors corrected. Don’t pay a service to actively monitor your reports; order a free report from one of the three companies every four months at annualcreditreport.com.
The FICO score is the one to get; it’s usually closest to what your lender will use to judge you. Your bank and/or credit card company may provide it free. (Consumers Union, the policy and avocacy arm of Consumer Reports, is pushing for a free FICO score for all.)
Editor's Note: This article also appeared in the March 2016 issue of Consumer Reports magazine.
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