Most homebuyers and renters have experienced that chill when a real estate agent asks them that one question: How is your credit? But as of August 14, 2018, that question will be haunting fewer potential homebuyers.
A recent study from the New York Fed’s Center for Microeconomic Data found that the number of collections accounts and the number of individuals with a collections account on their credit report shrank between June 2017 and June 2018. The change comes from a 2015 settlement between 31 state attorneys general and three credit unions—Experian, Equifax and TransUnion—that created the National Consumer Assistance Plan, which allowed for the companies to limit reporting any credit errors that may impair consumers’ scores. Now that the settlement has gone into action, credit reporting agencies are tasked with collecting more frequent and accurate information, and removing some medical bills, library fines, and traffic tickets from influencing a score.
This translates to many consumers seeing a boost to their credit scores of between 11 and 40 points. But before you get excited, there is a caveat: The boost affected, on average, consumers who had a credit score in the low 500s, which is generally seen as bad or poor credit. (The average credit score as of April 2017 for those 30-39 years old was 671.)
Even though 40 points is a small boost, it might be enough for some people to be boosted into the next category. For example, if someone had a “bad” credit score of 545, but they received a 40 point boost from the settlement, then they’d have jumped into the “poor” category.
So what does this mean for those who would like to buy a home? Well, to contextualize this, 680 is usually good enough to get a conventional mortgage. However, FHA loans only require a 500-579 credit score for a 10 percent down payment, and 580 for a 3.5 percent down payment. So, in some cases, this 11 to 40 point bump might be enough for certain people to qualify for a mortgage, says Dr. Mark Fleming, chief economist at First American in Washington, D.C.
“This upward shift of credit scores is more about being able to get in and access the mortgage credit market in the first place to be able to buy a home,” he said. Though he doesn’t believe the boost is enough to create a surge in homeownership demand, he does think the credit boost is enough to help some borrowers become eligible for home financing, and others to possibly get a cheaper mortgage.
However, Fleming cautions against buying a house now just because you can—if your credit score is high enough to get a mortgage, you still have to calculate how much you can spend per month on the mortgage and how much you can afford to borrow. He reminds those on the lower end of the credit spectrum that if you’re looking in a market where prices are high, a stronger credit score isn’t going to make that home any more affordable month to month. The same houses are available to you; you just now have more options to pay for it.
Dr. Lynn Reaser, a chief economist and adjunct professor of economics at Point Loma Nazarene University, agrees, emphasizing how lower interest rates can help people achieve homeownership. However, she, too, is cautious about those with lower credit entering the market and says that prospective homebuyers should be aware of two major hurdles they face: Rising home prices and interest rates.
“First, home prices continue to rise rapidly, with some prices currently up 5.6 percent from a year ago,” Reaser said, via email. “Second, mortgage rates are climbing with the 30-year conventional mortgage rate at around 4.5 percent, up from 3.5 percent two years ago.”
The housing market where you’re looking is also a big factor of whether this boost will help you afford and finance a home. Those with lower credit scores are more likely to be approved for lower interest rates in cities like Pittsburgh, Pennsylvania; Dallas/Fort Worth, Texas; Detroit, Michigan; St. Louis, Missouri; and Cincinnati, Ohio, where the housing markets are less competitive and buyers have the upper hand. However, if you were looking in the San Francisco Bay Area—where a family earning $135,000 can only afford 20 percent of homes on the market—you would have a hard time finding a home whose mortgage you would be approved for and afford.
Additionally, with a predicted 2020 recession looming, potential borrowers with lower credit should be extra cautious about biting off more than they can chew. If you want to apply for a mortgage (now that you are eligible for one), be aware of the pitfalls of the Great Recession, where nearly four million houses were foreclosed on in each year, according to a report by the Institute for Policy Research at Northwestern University.
“What’s more important to preventing the risk of foreclosure isn’t necessarily the equity you have in your home, as much as your continued ability to make your mortgage payment,” Fleming says.
If you have money saved away, but your credit score was keeping you from getting a low-interest conventional mortgage, then the boost might help you qualify. And since putting down more money as a down payment creates more of a buffer, lenders might offer you a better rate than they recently would have (though if one’s credit score was really low, a 40 point increase still may not be enough to even qualify at all).
However, if you’re taking advantage of a low-down payment mortgage through an FHA loan—you should still be practical and not buy more than you afford. Conventional advice is that your housing costs shouldn’t take up more than 28 percent of your total gross income, and that your total debt (including student loans, car loans, etc.) shouldn’t take up more than 36 percent.
“Get a credit report, check your credit score, see how you’re doing—maybe you thought you wouldn’t be able to buy a home, take another look. Maybe it’s gotten better,” Fleming said.
And even if your score hasn’t changed, it’s still a good time to take account of your credit and finances and make a plan to improve.