- The way credit is scored and mortgages are underwritten is putting low-income borrowers at a disadvantage.
- Lenders should have more freedom to count nontraditional credit, such as rent and utilities, in a borrower’s credit history.
- The industry must change the way it treats student loan debt, which is increasingly keeping borrowers off the housing ladder.
- Skylar Baker-Jordan is a freelance writer who has worked in the mortgage industry.
- This is an opinion column. The thoughts expressed are those of the author.
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America is in a housing crisis. “US home sales are surging. When does the music stop?” asked the New York Times’ Stephanos Chen last month. CNBC reports that “when is the housing bubble going to crash?” is a “red hot” Google search. Meanwhile, US News and World Report warns that “cities need a building boom to avoid a housing bubble.”
While inflated housing prices might be concerning, it is not the most pressing housing crisis facing America today. Much more alarming is the lack of affordable housing and the lack of financing options for low-income borrowers. The way we score credit, and the way we qualify borrowers, is inherently classist, and America’s fixation on wealthy borrowers and its credit scoring system are unfairly keeping low-income but responsible people off the housing ladder. If we really want to help people into homes, we must change the way we qualify borrowers for mortgages.
The lack of affordable housing is often cited as the most pressing obstacle to homeownership. This is indeed a problem. The coronavirus has left many homeowners reluctant to sell, whether for fears of financial insecurity or because they didn’t want strangers traipsing through their home during a pandemic. However, for those of us familiar with the mortgage industry – which I spent much of the past decade working in – the shortage of available homes for sale is nothing new.
In cities such as Chicago where I spent much of my mortgage career, deconversions are turning multi-unit dwellings to single family homes. An insufficient supply of newly constructed homes – a chronic problem since the Great Recession – has further led to a lack of supply throughout the country, especially for homes lower-income buyers can afford. According to the National Association of Realtors, home sales in the $100,000 – $250,000 range fell 11% from February 2020 to February 2021, while home sales over $1 million rose by 81%.
This means that lower-income homebuyers are competing for fewer available houses, but the problem does not end there. Virtually all of these borrowers will require a mortgage. While mortgage rates are historically low, mortgage guidelines are historically tight. This makes it difficult for responsible low-income borrowers to obtain a loan.
From an underwriting perspective, you want to look at the “Three Cs:” capacity to repay, collateral, and creditworthiness. Certainly, you want to know a borrower makes enough money to make timely mortgage payments and that they have a sufficient down payment (so that they have a financial stake in making said timely payments) and the home is worth what you are lending. It is how we determine creditworthiness, however, which is unfairly punishing lower-income borrowers.
You must have credit to get credit. Depending on the lender and the investor – that is, who the loan will be sold to on the secondary market, which is where servicing rights to loans as well as the mortgages themselves are sold (most often Fannie Mae or Freddie Mac) – you will need a certain amount of existing tradelines in order to obtain a mortgage. Yet even applying for credit can lower your score. Those with higher scores – usually (but not always) higher-earners – are better able to absorb this blow. Furthermore, lower-income and younger borrowers are less likely to have credit cards and other traditional tradelines that actually report to the bureaus that score credit, and a history of racial discrimination has left Black Americans at an unfair credit disadvantage.
These people are, however, paying bills, and often on time. Most people, even with insufficient traditional credit history, pay rent, electric, water, gas, phone bills, and so on. Yet these bills do not report on credit unless they go into collections, meaning that the bills lower-income people are paying do not help them but can hurt them.
This puts lower-income borrowers at a disadvantage and paints an incomplete picture of a borrower’s creditworthiness. After all, someone who might be delinquent on their credit card or jewelry payment might be very consistent in paying their rent and their electric bill, prioritizing needs (like housing) over luxuries. Credit reports will never show this.
This presents another problem with credit underwriting: We do not account for the bills people actually need to pay. Because the debt-to-income ratio (DTI) used in underwriting comes from the debts reporting on a borrower’s credit report, monthly expenditures like utilities and car insurance are not counted (again, unless they go delinquent). Adding these “nontraditional tradelines” to a credit report means counting them against the borrower when calculating their DTI. While some might argue that including these would do a disservice to lower-income borrowers, as it would increase the number of debts that underwriters must count against them (thus lowering purchase power), it is important that borrowers do factor these bills into any decision to buy a home. Including them in the DTI ratio would give everyone, including borrowers, a better idea of what they can and cannot reasonably afford.
Lenders are beginning to understand this problem. Quicken Loans is urging millennials to take out credit cards to drive up their credit score, while Veterans United – which specializes in lending to military veterans – touts the use of alternative tradelines to qualify VA borrowers. But simply utilizing nontraditional credit to gain a more accurate portrait of a borrower’s creditworthiness is not enough to address the lack of housing for lower-income Americans. We need to change the way we underwrite borrowers.
Down payment for a dream
Over the past decade, a cottage industry dedicated to dissecting why millennials are not buying homes has emerged. While many point to delayed marriage ages and a more rootless existence among this generation, the numbers show otherwise. A 2019 survey from the Urban Institute found that 53% of millennials said they could not afford a down payment, while 33% said they could not qualify for a mortgage.
Much of this is due to student loan debt. 83% of non-homeowners say they have student loan debt keeping them from buying a home. Lenders and investors need to look at new ways of treating this debt, which is increasingly ubiquitous and hindering borrowers’ ability to obtain a mortgage. Many borrowers defer student loans or are on income-based repayment plans. Fannie Mae has switched to factoring the actual payment into a borrower’s debt-to-income ratio, but FHA still takes “the greater of 1% of the outstanding balance on the loan; or the monthly payment reported on the Borrowers credit report; or the actual documented payment.”
Because of this, loan officers and underwriters are frequently forced to qualify borrowers with payments which are higher than the borrower’s actual payment. This lowers the purchase price and loan amount for which a borrower can qualify, hindering their ability to bid for homes in a market skewing more expensive by the year. And while it is true that the Federal Housing Administration (FHA) allows for higher DTI ratios than conventional lending, too often I have seen student loans put borrowers above even that qualifying threshold. This disproportionately hurts low-income borrowers, who might not qualify for conventional loans so rely on FHA to access credit.
This problem shows no signs of going away. Student loan debt is at a crisis point in the United States, and higher education an increasing necessity in an ever-changing job market. I saw this change happen in real time in the mortgage industry. The entry-level position I was hired for in 2011 then required only a high school diploma, but within two years my company was requiring entry-level applicants to have a college degree.
The mortgage industry has yet to adjust to this new reality. Underwriters should be allowed to treat student loans as they currently treat medical debt. Recognizing a fundamental unfairness in America’s healthcare system, lenders are regularly able to discount medical debt from a borrower’s DTI ratio. They should look at student loans the same way, understanding them as a necessity which should not stop borrowers from buying a home.
As anyone who has ever lent on new construction knows, it takes a long time to build a home. The housing shortage is not going to end anytime soon. We need to look at other ways to help solve America’s housing crisis, including making access to home loans fairer and more equitable. By modernizing credit scoring and underwriting practices, the mortgage industry can do its part to help a new generation of hard-working Americans achieve the dream of home ownership.