The first changes in 25 years
Most lenders want to make a loan that they can sell to the likes of Fannie Mae or Freddie Mac, the quasi-government agencies that fuel the mortgage market.
Here's how the automated process currently works. A lender enters a borrower's application information into an underwriting system, most often directly connecting to Fannie or Freddie. A credit report is pulled, and then an algorithm considers risk and eligibility factors and within minutes returns a recommendation.
While the lender always makes the final decision, getting a home loan approval from Fannie or Freddie is as close as you can get to sealing the deal. If you don't get that stamp of approval, you'll have to go through a manual loan approval process, which most lenders try to avoid.
Until now, this robo-underwriting has considered the usual factors: how big the loan is compared to the home's value, your debt-to-income ratio, how much of your available credit you use -- as well as assets, your credit score and a standard credit report.
"The mortgage credit report hasn't changed in probably 25 years," says Mindy Armstrong, senior product manager with Fannie Mae.
The credit report only shows who and how much you owe, and if your payments are made on time. That is what's changing.
How you pay your credit cards could help you get a mortgage
After the June 25 update, the system will analyze what's called trended credit data. For Fannie Mae, that means a 24-month accounting of not just if you pay on time but how you pay your credit card balances. Do you pay just the minimum due, more than that or the whole balance each month?
"We'll be able to see the balance, the scheduled payment and the actual payment" for each account, Armstrong says. This data will only cover credit card accounts for the most recent 24 months, and it may not be available for every account you have. But it will shed some light on the type of risk you represent.
As an example: Abby makes a minimum credit card payment, on time, every month -- while Callie pays off her balance each month. Currently, the system can't differentiate between the two borrowers. But with trended credit data, the system can determine that Callie may be a lower-risk borrower.
In fact, Fannie Mae says research has shown that borrowers who pay off their credit card every month are 60% less likely to become delinquent than borrowers who make only the minimum payment each month. And borrowers who never exceed their credit card limit are 75% less likely to become delinquent than borrowers who have exceeded their credit card limit in the last 12 months.
"Borrowers who are making more than the minimum payment, or paying their credit card off every month, will be more likely to get an 'approved' recommendation, or more likely to be able to get a loan, than they would today," Armstrong tells NerdWallet.
Bill Banfield, vice president of Quicken Loans, agrees that this type of credit card consumer -- called a "transactor" -- will be rewarded under the new procedures. But he points out trending credit data is still only one among many metrics affecting the approval decision.
"If a first-time homebuyer can show a history of paying off their debt balances, this may give them an advantage when applying for a mortgage," Banfield said. "However, the traditional factors, like credit score, income and assets, are still weighted heavier than this trended credit data when applying."
Some homebuying barriers lowered
"So, this trended credit data is not going to make or break anyone," Armstrong explains. "But you could have a borrower that's kind of on the border of an 'approve' or 'not an approve' and this trended credit data, where they're paying their credit card off every month, or even making more than the minimum payment every month, could help move them into the 'approved' bucket."
However, it won't help you get a better interest rate, which is typically based mostly on your credit score.
One other modification: Current mortgage holders are currently considered less risky than applicants who don't have a mortgage. That goes away with the update. "This updated risk assessment will benefit first-time homebuyers," Armstrong says.
New hope for homebuyers with no credit score
One other big change coming to the Fannie Mae automated underwriting process affects borrowers with no credit score.
Loan applicants without "traditional" credit have always triggered a manual approval process. With Fannie Mae's update in June, lenders will be able to submit applicants without a credit score through the same automated process. And remember, automated is what lenders prefer.
The underwriting guidelines for these no-credit-score loans include:
- Borrowers must use the property as their principal residence.
- It must be a single-family home (and not a manufactured home).
- The loan must be for a purchase or a limited cash-out refinance.
- It must be a fixed-rate mortgage.
- The loan-to-value ratio must be no greater than 90%.
- And the debt-to-income ratio must be 39% or less.
The lender will then need to obtain proof of two nontraditional sources of credit history. One must be a housing rental payment history. The other can be a 12-month payment history on something like a utilities bill, auto or life insurance premiums, tuition, or even child-care costs.
Automating what was a manual underwriting process makes it easier and faster for lenders to process an application for potential borrowers with no credit score, Armstrong says.
"There could also be lenders who don't do these [no credit score] loans today that would be willing to do them, because there are lenders out there that don't like to manually underwrite at all," she adds.
Quicken Loans' Banfield agrees and says young adults may particularly benefit.
"Millennials who haven't utilized credit in the past but can show a history of making other payments on time, like cellphone and insurance payments, may now find the door open for conventional loans," Banfield says. "FHA also has an alternative option for those who don't have a traditional credit history, so it's important to speak with a trusted mortgage banker to find the best option for each person and individual situation."
Meanwhile, Freddie Mac has no immediate plans to integrate trended credit data into its automated underwriting system, but it will "continue to evaluate" such a move, according to a spokesman.
More from NerdWallet