America’s credit system makes no sense and student loans make it worse
- The way credit is assessed and mortgages are taken out puts low-income borrowers at a disadvantage.
- Lenders should have more freedom to count non-traditional credits, such as rent and utilities, in a borrower’s credit history.
- The industry needs to change the way it deals with student debt, which keeps more 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.
- See more stories on the Insider business page.
America is in a housing crisis. “Home sales in the United States are booming. When will the music end?” request Stephanos Chen of the New York Times last month. CNBC reports that “when will the housing bubble collapse?” is a “red hot” Google search. Meanwhile, US News and World Report warns that “cities need a construction boom to avoid a real estate bubble”.
While inflated house prices may be of concern, it is not the most pressing housing crisis America faces today. Far more alarming is the lack of affordable housing and the lack of financing options for low-income borrowers. The way we rate credit, and the way we label borrowers, is inherently classist, and America’s fixation on rich borrowers and its credit scoring system unfairly keeps low-income but responsible people out of it. housing scale. If we are serious about helping people get into their homes, we need to change the way we qualify mortgage borrowers.
The lack of affordable housing is often cited as the most pressing barrier to home ownership. This is indeed a problem. The coronavirus has left many homeowners reluctant to sell, whether for fear of financial insecurity or because they didn’t want strangers walking through their homes during a pandemic. However, for those of us familiar with the mortgage industry – in which I have spent much of the past decade working – the shortage of available-for-sale homes is nothing new.
In cities like Chicago, where I spent much of my mortgage career, deconversions transform apartment buildings into single-family homes. Insufficient supply of newly built houses – a chronic problem since Greater
– further led to a lack of supply across the country, especially for housing that low-income buyers can afford. According to the National Association of Real Estate Agents, home sales in the range of $ 100,000 to $ 250,000 have fallen 11% from February 2020 to February 2021, while sales of homes over $ 1 million increased 81%.
This means lower income homebuyers are competing less for available homes, but the problem doesn’t end there. Almost all of these borrowers will need a mortgage. While mortgage rates are historically low, mortgage guidelines are historically strict. 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:” repayment capacity, collateral, and creditworthiness. Certainly, you want to know that a borrower is earning enough money to make timely mortgage payments and has enough down payment (so that they have a financial interest in making said payments on time) and that the house is worth what you lend. This is how we determine creditworthiness, which unfairly punishes low-income borrowers.
You must have credit to get credit. Depending on the lender and investor – that is, who the loan will be sold to the secondary market, which is where the loan management rights as well as the mortgages themselves are sold (most commonly Fannie Mae or Freddie Mac) – you’ll need a number of existing transactions to get a mortgage . Yet even apply for credit can lower your score. Those with higher scores – usually (but not always) the highest incomes – are better able to absorb this blow. In addition, younger, lower-income borrowers are less likely to have credit cards and other traditional trades that report to credit rating bureaus, and a history of racial discrimination left black Americans at an unfair credit disadvantage.
However, these people pay their bills and often on time. Most people, even with poor traditional credit histories, pay rent, electricity, water, gas, phone bills, etc. Yet these bills don’t report on credit unless they go into collection, meaning the bills low-income people pay don’t help them but can hurt them.
This puts low-income borrowers at a disadvantage and paints an incomplete picture of a borrower’s creditworthiness. After all, someone who might be late on paying for their credit card or jewelry might be very consistent in paying their rent and utility bill, prioritizing needs (like housing. ) to luxury. Credit reports will never show this.
Another problem with underwriting is that we ignore the bills people actually have to pay. Because the debt-to-income ratio (DTI) used in underwriting comes from debts reported on a borrower’s credit report, monthly expenses like utilities and
are not counted (again, unless they become delinquents). Adding these “non-traditional trades” to a credit report means counting them against the borrower when calculating their DTI. While some might argue that including these would do low-income borrowers a disservice, as it would increase the amount of debt that underwriters have to charge against them (thereby reducing purchasing power), it is important that the borrowers do factor these bills into any home buying decision. Including them in the DTI ratio would give everyone, including borrowers, a better idea of what they can and cannot reasonably afford.
Lenders are starting to understand this problem. Quicken Loans is urge millennials to take out credit cards to boost their credit score, while Veterans United – which specializes in loans to military veterans – touts the use of alternative trades to qualify VA borrowers. But simply using non-traditional credit to get a more accurate picture of a borrower’s creditworthiness is not enough to address the housing shortage for low-income Americans. We need to change the way we guarantee borrowers.
Down payment for a dream
Over the past decade, a cottage industry dedicated to dissecting the reasons millennials don’t buy homes has emerged. While many cite delayed marriage ages and a more rootless existence within this generation, the numbers show otherwise. A Urban Institute survey 2019 found that 53% of millennials said they couldn’t afford a down payment, while 33% said they couldn’t qualify for a mortgage.
This is largely due to student debt. 83% of non-owners say they have student loan debt preventing them from buying a home. Lenders and investors alike need to look for new ways to deal with this increasingly pervasive debt hampering borrowers’ ability to secure a mortgage. Many borrowers postpone their student loans or follow income-tested repayment plans. Fannie Mae a moved to including the actual payment in the borrower’s debt-to-income ratio, but FHA still take “the greater of 1% of the outstanding loan balance; or the monthly payment shown on the borrower’s credit report; or the actual payment documented.”
For this reason, loan officers and underwriters are often required to qualify borrowers whose payments exceed the borrower’s actual payment. This lowers the purchase price and loan amount at which a borrower can qualify, hampering their ability to bid on homes in a market that is getting more expensive year on year. And while it’s true that the Federal Housing Administration (FHA) allows higher DTI ratios than conventional loans, I’ve too often seen student loans place borrowers above even that qualifying threshold. This disproportionately hurts low-income borrowers, who might not qualify for conventional loans, so rely on the FHA for access to credit.
This problem shows no signs of going away. Student debt is at a point of crisis in the United States, and higher education, a growing need in a constantly changing job market. I have seen this change happen in real time in the mortgage industry. The entry-level position I was hired for in 2011 only required a high school diploma at the time, but within two years my company required entry-level applicants to have a college diploma.
The mortgage industry has yet to adapt to this new reality. Insurers should be allowed to treat student loans as they currently treat medical debts. Recognizing a fundamental injustice in the American health care system, lenders are regularly able to discount a borrower’s DTI ratio medical debt. They should view student loans in the same way, seeing them as a necessity that should not prevent borrowers from buying a home.
As anyone who has ever loaned for new construction knows, it takes a long time to build a house. The housing shortage is not going to end anytime soon. We must look for other ways to help resolve the housing crisis in the United States, including making access to home loans fairer and more equitable. By modernizing credit reporting and underwriting practices, the mortgage industry can do its part to help a new generation of hard-working Americans realize the dream of homeownership.