How Personal Debt Can Close the Front Door to Homeownership
Jarod Jones is Sales Director of Mortgage Verifications Services with Equifax Workforce Solutions, responsible for client management, project management, strategic planning, solution sales, market analysis and negotiations. During his tenure at Equifax, he has led a successful mortgage solutions team and helped assure the execution of goals and objectives.
Debt isn’t inherently bad; it can help people access extra cash for personal purchases like a new automobile, traveling, or even the schooling they need to unlock job opportunities and advance their careers. However, it is still a financial burden and, for many Americans, can stand in the way of fiscal freedom. For instance, if a consumer is exploring homeownership, outstanding debt could prevent them from taking out a mortgage, especially in light of steep housing prices and rising interest rates.
Technology in the financial sector continues to evolve, allowing lenders to access instant verified data, such as income and employment data, that can be used in conjunction with a traditional credit score to better gauge a borrower’s propensity to repay debt – thereby helping to reduce the risk of extending loans to borrowers who are already overextended financially. With lenders now recognizing the power of alternative data during underwriting, homeownership decisioning can be made with more confidence and less risk – leading to healthier financial portfolios.
The Downside of Debt When Seeking Homeownership
The past year was brutal for many Americans, with high inflation draining savings accounts at an alarming rate. Many people have utilized alternative payments like Buy Now Pay Later or overcharged credit cards to make ends meet, leading to unwanted debt.
So, what does personal debt have to do with home ownership? Current debt influences a lender’s willingness to extend a loan. When evaluating loan applications, lenders frequently assess a borrower’s debt-to-income ratio (DTI), which compares monthly debt payments to monthly income, expressed as a percentage. The higher the ratio, the more likely the loan will have a higher interest rate or even be denied. A DTI ratio of under 36% is ideal for mortgage approval.
In short, this metric determines the percentage of monthly inflows already committed to repaying obligations, such as rent, credit card bills, and student loans. The higher the percentage, the more constrained income is – and the lower the odds of qualifying for another loan or a lower interest rate.
The Power of Alternative Data
Monthly debt obligations can mount quickly, often causing borrowers to miss payments and hurt their credit scores. Financing cars, credit cards, and hefty investments like tuition can be costly.
Fortunately, another factor can work in the borrower’s favor: alternative data. Alternative data is a blanket term that applies to financial data outside the traditional credit reporting data. In other words, employment history, monthly income, and utility and rental payment histories could factor into a lending decision. The same goes for secondary sources of income like a part-time job or rental property. Even occupation and educational background could provide insight into a borrower’s loan repayment ability. Financial institutions are able to leverage alternative data when underwriting loans in order to see a more holistic picture of the borrower.
What This Means for Potential Homeowners
Although overall debt burden can be a deal breaker, the support of alternative data could help borrowers in the market for a new home, particularly those on the cusp of otherwise qualifying.
While mortgage lenders typically prefer to see a DTI of 36% or lower, some institutions could make exceptions for higher ratios based on their review of alternative data. More than 77 million consumers have thin credit files or are credit invisible – yet many of these consumers may have the income and employment status that otherwise makes them qualified loan applicants. Even if a borrower’s credit score is low, widening the scope of evaluation by examining their job history and income can reduce risk and better position borrowers to secure lower mortgage rates.
Understanding consumer financial health beyond the traditional approach allows lenders to think outside the box and act more inclusively. While outstanding loans are critical in credit scoring models, digital verification capabilities can allow borrowers to also benefit from positive payment histories.
Homeownership Shouldn’t Be a Fantasy
Accumulated debt has prevented many Americans from pursuing homeownership. However, the increased use of alternative data could pave the way for lenders to provide more attainable financing for many people. Mortgage lenders utilizing an automated solution, such as income and employment data from The Work Number® by Equifax, which can equip them with a broader view of a consumer’s financial history, can gain a more comprehensive insight into a borrower’s propensity to pay amidst these uncertain times. In a volatile market, lenders harnessing these digital capabilities can bring borrowers who have thin or no credit files out of the shadows of the credit system and into the home of their dreams.
(Views expressed in this article do not necessarily reflect policy of the Mortgage Bankers Association, nor do they connote an MBA endorsement of a specific company, product or service. MBA NewsLink welcomes your submissions. Inquiries can be sent to Mike Sorohan, editor, at firstname.lastname@example.org; or Michael Tucker, editorial manager, at email@example.com.)