A reader just told me that he was able to get a client approved for a refinance with a sub-500 FICO score.
And this is a conforming loan, those backed by Fannie Mae and Freddie Mac.
For reference, the pair up until very recently required a minimum 620 FICO score for any approval.
But they quietly and unceremoniously did away with their credit score minimums in favor of a more holistic approach that factors in a “comprehensive analysis of risk factors to determine eligibility.”
While I thought the change wouldn’t amount to much loan volume, I was mistaken.
Fannie/Freddie Refi Approved with a 487 FICO Score!
I was shocked when I heard this, but it’s apparently true. A loan officer was able to run a file through Fannie or Freddie’s (not sure which) automated underwriting system (AUS) and get it approved with a 487 FICO score.
While it sounds almost unbelievable, it’s the real deal. And the loan officer got the all-important Approve/Eligible message.
This means they can move forward and get the thing funded. At first glance, I thought this was an unacceptable amount of risk.
After all, a 487 FICO score is dismal. It takes work to get a score that low. Some serious derogatory work.
But then I learned more details of the loan. For one, and this is a biggie, it’s set at a loan-to-value ratio (LTV) of just 68%.
Put another way, 32% home equity, which is a pretty favorable cushion to have, for both the borrower and the lender.
That means the borrower has a lot of skin in the game if the loan were to go bad. And the lender would likely be able to sell the property without a loss.
Another plus is it’s a rate and term refinance, meaning the borrower is applying for a lower interest rate.
They are actually lowering their mortgage rate from around mid-7% to 5.99%. So it’s a sizable rate reduction.
That will translate to a significantly lower monthly payment, which logically means the borrower will be more capable of making the payment.
After all, if it’s a few hundred bucks less per month, it’s more achievable, and by definition it reduces default risk.
Conversely, if the homeowner doesn’t refinance and stays with their original 7% loan, the chances of default are higher.
So you can actually see the use case in allowing loan scenarios like this to make their way through underwriting, despite the terrible credit score.
This Probably Won’t Be a Common Scenario
While it sounds like we’re repeating past mistakes by ushering in higher risk, I don’t expect loan scenarios like these to be common.
For one, typical LTVs are usually a lot higher than 68%. You’re more likely to see someone attempting to refinance with say 5 to 10% equity, if even that.
Someone with this much equity likely came in with a large down payment if their current rate is 7%.
Also, Fannie and Freddie are still documenting the borrower’s income, assets, credit history, and employment.
So it’s not a free-for-all like it was back in 2006 where you could qualify for a refinance with just a credit score. And zero equity!
You can also make the argument that this a risk-off situation where the borrowers that qualify for these loans are lowering their payments.
The alternative might be a costly loan modification, which is a burden on loan servicers and also hurts MBS investors, etc.
Allowing these types of loans to get approved through normal channels is arguably more efficient and cheaper for all involved.
I’ll be keeping an eye on it for sure, but despite my initial reaction that a sub-500 FICO score is ridiculously low for a Fannie/Freddie approval, I can see where some of these scenarios actually make sense.
And why Fannie and Freddie got rid of credit score minimums to begin with.
Before creating this site, I worked as an account executive for a wholesale mortgage lender in Los Angeles. My hands-on experience in the early 2000s inspired me to begin writing about mortgages 19 years ago to help prospective (and existing) home buyers better navigate the home loan process. Follow me on X for hot takes.