For many homebuyers, establishing credit came naturally once they began working, applied for a credit card, took out a car loan or paid back student loans. But what about potential homebuyers who don’t have a credit score, either because they are averse to credit cards 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 nontraditional 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 that 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 canceled checks or verification from a landlord of on-time rent payments.”
Here are several other items that can be used for nontraditional credit verification, Ross says:
- Utility bills for gas, electricity or water, as long as they are paid separately from your monthly rent.
- Phone and cable bills.
- Car insurance, renters insurance, life insurance 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.
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“You need at least 12 months and sometimes as many as 24 months of payments to prove your creditworthiness,” Ross says. “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 affect 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,” Madison says. “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 United States 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 credit history long enough to produce a score still need alternative sources of credit when applying for a loan. The Consumer Financial Protection Bureau recently released a study that showed there are often 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,” CFPB Director Richard Cordray said in a news 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, Madison says, is that borrowers are set up for false expectations.
“They may either be expecting to qualify for a better 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,” he says. This is why having alternative sources of credit, which 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,” Madison says.
It’s especially important that prospective buyers with thin credit consult with a mortgage lender, Ross says. A lender can provide them with a plan to follow to improve their chances of qualifying for a mortgage.