Before the most recent economic crisis it was easier to get a home loan even with bad credit and without a co-borrower. The mortgage industry had loosened standards so more people could enjoy owning a home. That loosening created a housing bubble. Once the bubble burst the industry had to recalibrate.
Today, virtually all mortgage lenders have tightened their credit standards. They have introduced new requirements for those looking to secure a home loan or refinance their existing loan.
Your credit score and your credit report matter more than ever before. If your spouse has less then stellar credit it could make getting a home loan more difficult. It could also end up costing you a lot of money in the form of a higher interest rate and a higher payment.
Uneven Credit Scores: What Happens When One Spouse Has a Substandard FICO Score?
Mortgage lenders always review your FICO score and your credit report. The FICO score is the most important. It determines, to a large degree whether the loan will get approved. Credit scores have a big impact on the interest rate that you'll get on the home loan. If both spouses have similar credit scores it's easy to estimate what the rate and payment terms will be on the loan.
But if one spouse has a high score, and the other has a low score, things can get more difficult.
The reason for this increased degree of difficulty is a policy known as "low score default." By default, a mortgage lender will attempt to approve and originate a loan based on the lower of the two credit scores offered. That's because approving borrowers for a mortgage is a game of risk. Lower credit scores represent a higher risk of foreclosure or short sale. When a homeowner defaults on their loan it costs the banks a lot of money.
So if you're getting a home loan with a spouse or partner with a lower credit score then you be prepared to have a higher rate. In some cases, a very low score may cause the mortgage to get rejected altogether. Talk to your spouse or partner before deciding to get a new home loan or refinancing.
Score Specifics: Which Score is Used for Mortgage Qualification?
Your credit score comes from the big three reporting agencies: TransUnion, Equifax, and Experian.
Lenders will look at all three scores when considering a loan application. Each agency reports scores differently so the lender takes all scores into consideration.
Usually the lender uses the "middle score" for each applicant. This is where things get tricky. You could have two poor credit scores, but a third score that's actually quite high. Lenders still wouldn't use that higher score, because a lower score is the "middle" score. Imagine, for instance, that your three credit scores are 740, 640, and 638. In this case, the score used for a mortgage is the middle 640 score.
When two people are applying for a home loan together the lender will use the "lowest middle" score. Meaning, the lowest middle score out of the two borrowers. If your scores are 740, 640 and 638 and your co-borrower's scores are 740, 635 and 630 the lender will use the 635 score.
Before you start pointing fingers and playing the blame game consider these creative moves to getting a great home loan...
Consider Qualifying for the Mortgage Using Only the High-Scoring Spouse
Have the person with the highest credit score apply for the home loan on their own. This takes the low scores out of the equation.
The main issue with having just one person apply for the loan is income limitations. Annual income is a big factor in getting a home loan. Lenders want to make sure you can afford the payment and that you won't default. If you apply for a home loan on your own then only your income will be considered. This could decrease the size of the loan you can qualify for.
Show Greater Capacity to Pay By Combining Finances
Though it's not possible to combine incomes if only one spouse is applying for the mortgage, it's still possible to show greater capacity to pay.
Most lenders take into consideration a person's liquid assets when they apply for a home loan. Simply put, liquid assets include any money stored in money markets or savings accounts. Really, we're talking cash and it's equivalents. If you and your spouse have individual accounts with liquid assets you could combine these into a joint account. These additional assets will show the lender that you have a greater capacity to pay the loan.
In most situations lenders are going to ask for the two most recent statements. You would want to make the changes on the accounts so they are reflected on the two most recent account statements.
Add Someone Else as a Co-Borrower Instead of the Other Spouse
If you have found your dream home but it requires both incomes you could ask someone else to co-sign on the home loan. Maybe one of your parents is willing to be the co-signer on the loan. This will put the parent on the hook for the mortgage if you can't make payments on the loan at any point in the future. But it would allow you to qualify for a mortgage and buy your dream home.
This would give your spouse time to clean up their credit report and raise their FICO numbers over the next several years. This will make it easier to refinance the home loan under both spouses' names in the future and remove your family member from the mortgage.
Just because you or your spouse has a low credit score it doesn't mean you can't get a great home loan. It might just mean that you have to get a little creative.