Anyone who has been keeping up with minimum payments on credit card debt each month may fondly imagine they are managing this debt quite well. However an article in realtor.com points out the risks in taking this approach and is advising people that they may want to change up their payments before applying for a home loan.
Apparently Fannie Mae, which is responsible for offering government backed loans to more than 25% of mortgage applications in the country has just revised its software that assesses risk. Now it will factor in more details on how borrowers are paying off debt. In the past the credit report generated by Fannie Mae generally showed how much available credit had been used up and whether people had been diligent about making monthly payments on time. However the latest version of this software also shows lenders the amount of the payment made each month over the past two years, allowing them to see whether people have just made minimum payments, have cleared the debt completely or have taken an approach somewhere in the middle. This software is used by around 2000 lenders and more than 10,000 mortgage brokers.
The aim of including these new details is to help lenders better assess if people are able to manage their debt properly and if they’ll be able to cope with mortgage payments. The article gives the example of two people with exactly the same credit profiles except where one pays off the entire balance of their credit debt each month or at least pays more than the minimum. They would be more likely to be approved for a mortgage. Additionally, it might not be necessary to pay much more than the minimum to increase the chance of getting a loan as it’s believed anyone paying 30% or more of their balance each month will see an improvement.
Those who pay off the entire balance each month will be viewed even more favorably. There is a very good reason for this as research has shown that people who take this attitude towards debt are 60% less likely to fall behind with mortgage payments compared to borrowers who only make the minimum payment each month. Apparently Fannie Mae has also indicated that paying more than the monthly minimum will be particularly helpful for borrowers who already have delinquencies on their credit report, showing lenders that a late payment wasn’t reflective of their general ability to repay debt.