For many homebuyers, establishing credit came naturally once they began working, applied for a credit card, car loan or paid back student loans. But what about potential homebuyers who don't have a credit score either because they are credit card averse or have yet to build up a substantive credit history -- can they still apply for a mortgage?
The answer is "yes," but "it's exceedingly difficult to obtain a mortgage without a credit score," says Tim Ross, president and CEO of Ross Mortgage Corp. in Royal Oak, Mich. "Lenders use automated underwriting systems that base a loan decision on certain criteria including a credit score. But there are some non-traditional sources that can be used for credit verification."
Mortgage lenders typically require a credit score of at least 620 or 640 to even consider an applicant for a loan.
Whether you prefer not to use credit cards, are new to this country or are simply a younger borrower who hasn't built up enough credit history, there are some alternative sources mortgage lenders can use to determine your credit risk.
While most lenders require three or more sources of credit, Clint Madison, a senior mortgage banker with Envoy Mortgage in Walnut Creek, Calif., says, "I've worked with borrowers who have a slim credit file and been able to get them approved for a loan. The first thing we look for would be 12 to 24 months of cancelled checks or verification from a landlord of on-time rent payments."
Alternative sources of credit
Here are several other items that can be used for non-traditional credit verification, according to Ross:
- Utility bills for gas, electricity or water as long as they are paid separately from your monthly rent
- Phone and cable bills
- Car insurance, renter's insurance, life insurance payments or medical insurance payments if they are not paid by payroll deduction
- Child care or school tuition payments
The more evidence you can provide that indicates a history of on-time payments the greater your chances of qualifying.
"You need at least 12 months and sometimes as many as 24 months of payments to prove your creditworthiness," says Ross. "A bigger down payment offsets your credit risk and so does your job stability, your cash reserves and a high income in relation to your debts."
Credit history matters
The reason for your lack of credit history will also impact your ability to qualify for a loan.
"If you're living with your parents and have yet to establish any credit, it's pretty much impossible to get a loan unless your parents are willing to co-sign for you," says Madison. "The parents will need a credit score at a minimum of 660 and you'll need to have at least two months or maybe as much as six months of principal, interest, taxes and insurance payments in cash reserves in the bank."
Borrowers who are new to the U.S. may have a credit report from another country. Ross says those credit reports can be used to create a record of bill payments for a loan application.
You may not know your true credit score
Even consumers who have a long enough credit history to produce a score still need alternative sources of credit when applying for a loan. The Consumer Financial Protection Bureau (CFPB) recently released a study that showed there are discrepancies between the credit score given to a consumer and one reported to a lender.
"This study highlights the complexities consumers face in the credit scoring market," said CFPB Director Richard Cordray in a press release. "When consumers buy a credit score, they should be aware that a lender may be using a very different score in making a credit decision."
The problem, says Madison, is that borrowers are set up for false expectations.
"They may either be expecting to qualify for a better mortgage rate than they do, or they may lose out on opportunities for which they don't believe they will qualify, when, in reality, they can," says Madison. This is why having alternative sources of credit -- that can help prove your ability to repay a loan -- is important.
Ross says it takes just six months of credit card usage to generate a credit score, but lenders would also need other sources of credit in addition to your six-month-old score.
"Using alternative credit doesn't change someone's credit score, so if your score is low, all you can do is let time pass while you do the right thing over and over again," says Madison.
It's especially important that prospective buyers with thin credit consult with a mortgage lender, says Ross. They can provide you with "a road map to follow to improve your chances of qualifying for a mortgage."
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Michele Lerner, author of "HOMEBUYING: Tough Times, First Time, Any Time", has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT's REIT magazine and numerous Realtor associations.