By Peter Miller
Lenders have an ongoing problem: No matter how many loans they create, they want to make even more. And that brings us to the 67 million people who lack the credit needed to borrow in today’s tough lending environment.
What if we changed credit standards so that more people without a traditional credit history could qualify for a mortgage?
That’s the basic idea behind a new alliance designed to extend credit much further than in the past. What makes this approach interesting is that it really addresses what many people feel has been a long-time unfairness in the credit system: the inability of consumers to get any benefit from common, consistent, on-time payments for such things as rent or utilities.
If you’re wondering how to buy a house with no credit, this information should be of particular interest to you. With a solid history of repayment, it may be possible to buy a house with no credit in the near future through alternative means.
Traditional Credit Leaves Consumers Behind
According to Jim Wehmann, a vice president with the credit score pioneer FICO, “You often need a credit history before you can get traditional credit.” This, of course, is a chicken-and-egg financial deal: You need credit to function in a modern society but you can’t get such credit without a credit history. At the same time, you can’t get a credit history without a credit report, and credit reports do not reflect all forms of spending.
Under the new system, FICO will use “alternative data” from information suppliers LexisNexis and Equifax to build an alternative scoring system that should help large numbers of people qualify for credit.
“We set out to help unbanked, underbanked, and disadvantaged people gain equal access to the standard credit products enjoyed by millions of Americans,” said Wehmann.
Getting more people into the credit system is not only good for consumers, it can also create more business for lenders. According to the Federal Deposit Insurance Corporation, “The existence of unbanked and underbanked households presents an opportunity for banks to expand access to their products and services and forge relationships with these underserved groups, ultimately increasing economic inclusion.”
The FDIC says that in 2015 — the latest year for which statistics are available — 7% of all US households were unbanked. In addition, 19.9% were underbanked. That’s another 24.5 million households without full credit access.
“We have millions of potential home buyers, car buyers, and just plain consumers who do not qualify for financing or even credit cards because they don’t fit within traditional credit definitions,” said Rick Sharga, executive vice president at Auction.com.
“Many of these individuals are perfectly good credit risks and have good incomes, but until this point they’ve been unable to get the benefit of their prompt payments and prudent financial management,” Sharga said. “There’s an unfairness to this, which can be reduced with the use of alternative credit scoring, and today’s Big Data solutions make the data needed to create this scoring readily available.”
The Future of Alternative Credit
FICO says that its “data scientists found that alternative data such as property records, telecommunications, and utility information can reliably be used to score 15 million consumers who do not have enough credit data to generate FICO scores.”
So what is alternative credit?
Joe Chaloux, a Fair Lending Examination Specialist with the FDIC, explains that examples of alternative credit include payments for such things as rent, utility bills, monthly insurance payments, child care, and rent-to-own agreements.
However — and this is crucial — alternative credit is not a substitute for bad credit.
“Alternative credit,” said Chalous, “does not replace ‘bad credit’ — so a person who has been late on credit cards or car loans could not use rental payments in place of the bad credit. If there were legitimate explanations for those late payments, such as a one-time event like a job loss or health issue, the applicant should make sure the bank knows that.”
According to the Office of the Comptroller of the Currency, a major bank regulator, “although many people now renting do not have traditional credit histories or scores, they do want to become homeowners.”
Fannie Mae estimates that 5 million renters without credit scores can afford to purchase a home. And about 500,000 new homebuyers without traditional credit scores complete a home purchase through FHA or the subprime market each year.
By taking advantage of nontraditional credit history programs now offered in the secondary mortgage market, lenders can avoid needlessly relegating would-be borrowers to the subprime or ‘Alt A’ market.”
In other words, the reason to have access to the credit system is that it can be the key to cheaper borrowing. Costly subprime mortgages are associated with borrowers who have poor credit, while “Alt A” loans in the recent past have included such toxic financial products as option ARMs and interest-only mortgages.
FICO estimated in late April that a borrower with an 800 score might pay 3.308% for a fixed-rate mortgage while a borrower with a 625 score would pay 4.897%. The difference for a $150,000 loan is substantial: A $150,000 mortgage over 30 years at the first rate costs $657.59 per month for principal and interest. The same loan at 4.897% has a monthly expense of $795.82. That’s a difference of $138.23 per month or almost $1,660 annually.
How to Build Alternative Credit
If your goal is buying a house and you don’t have traditional credit to rely on, the best thing you can do is focus on building alternative credit. To get the most from your monthly payments, always pay by check and not with cash. This gives you a payment record lenders can verify.
For instance, if you rent a private home a series of at least 12 checks can be used to prove full and timely payments. Also, keep such things as utility bills, insurance stubs, and other evidence from other recurring expenses that lenders can examine. Logically, if the bills do not show late payments they must have been properly paid.
You may also be able to buy a home with no credit by securing a home loan backed by the Federal Housing Administration. According to the U.S. Department of Housing and Urban Development, you may qualify for an FHA loan if you can show at least one year of:
- On-time rental payments with no delinquency
- On-time payments on other bills such as car insurance, utilities, and cell phone service
- No accounts in collections outside of medical bills
Buying a home without traditional credit can be challenging, but alternative credit is paving the way for more and better options in the future. If you are currently unbanked and have no plans to pursue traditional credit, the best thing you can do for your finances is to continue paying all of your bills in-full and on time. While you won’t build traditional credit this way, having a solid history of repayment may help you purchase a home in the future.