Non-traditional credit is credit that is not found on a traditional credit report, but can be verified in other ways. This type of credit is needed for those applicants that do not have a large credit file yet have a history of making payments on time to entities that do not report to the credit bureaus. A few examples include payments to utility companies, a landlord or insurance company. The use of non-traditional credit is meant to help those that would otherwise be ineligible to obtain a mortgage get into a home without unnecessarily high payments.
Credit history is meant to give potential lenders a look back at the number of trade lines that a consumer has open and how he pays those accounts. In order to have a credit history, there must be one account that is open for a minimum of 6 months and has a balance. This is not as common of an occurrence as it used to be before the economic downturn. This lack of a history can make it difficult for those that want to be homeowners to have the ability to do so even if they have the funds to make it happen.
The Tiers of Non-Traditional Credit
Non-traditional credit is broken down into 3 tiers. These tiers consist of:
- Tier 1 – Rent or utility payments (including phone, gas or electric payments)
- Tier 2- Insurance premiums (auto or life insurance)
- Tier 3 – Retail store payments, tuition, childcare, personal loans or automobile leases
Most lenders as well as the FHA and Fannie Mae require at least 12 months history from any account that is used for qualification purposes. In general, they want accounts from the first tier to use for qualification, but will move down the ladder when necessary. If rent is used, either a Verification of Rent or 12 months canceled checks will be necessary to prove the payments and their timeliness, as no more than one 30-day late payment will be acceptable for qualification purposes. If you wish to use the non-traditional credit, you will need at least one credit source from Tier 1 in order to continue.
Freddie Mac’s Exceptions
Freddie Mac is a little more lenient with its non-traditional credit requirements. It goes along with the same tiers and would like most of the sources to come from Tier 1, but will also allow union dues payments as well as regular deposits to a savings account for qualification. The deposits will need to occur over a 12-month period and the deposits must be made at least on a quarterly basis with the size of the account regularly growing over the 12-month period.
Get Everything in Line
If you are going to use non-traditional credit, it is important that you have other compensating factors to make a lender want to lend to you. This means having adequate amount of money in the bank, not only for your down payment, but also to serve as reserves, aka an emergency fund. You should also make sure that the home that you purchasing will allow your payment to be in line with the amount that you can afford, keeping your debt-to-income ratio as low as possible. When you make sure that you have compensating factors, it will make a lender more willing to use non-traditional credit for you to qualify you for the loan. Of course, as with any other risk factors, you will likely pay a higher interest rate and/or be charged origination fees to make up for the riskiness, but it will allow you to become the homeowner that you wish to be.Click to See the Latest Mortgage Rates»