Spouse's Bad Credit Creates Mortgage Mess

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BOSTON (TheStreet) -- Forget "Hey baby, what's your sign?" For anyone looking to buy a house with a spouse someday, "What's your credit score?" may be a better pickup line.

Thanks to recent loan-level pricing adjustments from Fannie Maeand Freddie Mac , the lower a person's credit score is, the higher the conventional mortgage loan rate. In the case of couples who apply for a mortgage together, one spouse's stellar score won't make up for the other's lousy one. The lender bases the rates only on the lower of the two credit scores.

"Current underwriting guidelines require that the lender default to the lower score to make a credit risk determination," says Robert McDonald, principal at Mass Mortgage Group in Medford, Mass. With a score-based system, "a real-life review of a couple's credit profile/history is not allowed, thereby possibly disqualifying the couple from obtaining a mortgage."

Mortgage rates are at epic lows, thanks in part to the European debt crisis. But requirements and penalties associated with credit scores are at epic highs, and only those with the highest credit scores can reap the benefits of the lowest mortgage rates.

Mortgage broker Sonya Pitt recently evaluated the loan application of a couple in which the husband had a Fair Isaac, or FICO, credit score of 720, while the wife's score was 680. FICO's credit scale ranges from 300 to 850. While 680 used to be a respectable score, most lenders won't consider lending to anyone with a score below 620 these days. For that couple, the difference between 680 and 720 would have meant a rate of 5.5% instead of 5%, says Pitt, president of the South Carolina Mortgage Brokers Association and a branch manager at Commonpoint Financial.

Pitt recommends that the spouse with the higher credit score apply for the loan alone with one income, even though two incomes on a loan would improve the important debt-to-income ratio. "It is the lowest score of either borrower, whether they're the primary wage earner or not," says Pitt.

Leaving one spouse off the loan also is becoming more common among long-married couples who are in the process of refinancing a home, says Don Frommeyer, treasurer of the National Mortgage Brokers Association in McLean, Va., and a senior vice president at Amtrust Funding, a mortgage brokerage in Carmel, Ind., who recently assisted a couple in which the husband had a deal-breaking score of 580, while the wife had a score of 800. "They ended up refinancing in her name only."

While leaving the lower score off the application makes practical sense for a high-scoring spouse with an income to match, "the reaction you usually get from the other spouse is that they feel a little hurt," Frommeyer says.

Brokers can ease the emotional sting of exclusion by explaining that even if one person is left off the loan, both members of the couple are still allowed to sign the title, Pitt says.

In certain states, if couples want to leave one person off the loan, it may make sense to buy the house before they get married. Massachusetts, Ohio and Kentucky are among the states that adhere to "dower" or "curtesy" laws. A dower is the portion of a deceased husband's property that a widow is legally entitled to use to support herself and their children. A curtesy is the portion entitled to a widower if the couple had kids during the marriage.

In those cases, a bank may have trouble when the loan-paying spouse runs into financial trouble and wants to sell the house, but the other spouse still has rights to the house. However, spouses sign away their inherent dower/curtesy rights if they sign the legal documents associated with the house. Therefore, in states with dower or curtesy laws, some lenders may require both spouses to sign the loan in case of a foreclosure, according to officials at the Quality Title & Abstract Agency in Eatontown, N.J.

"The problem we run into is when you have a couple that's separated, and one of them leaves the state," says Jerry Collyer, president of the Florida Mortgage Professionals Association and a regional vice president at U.S. Capital. "By signing the security agreements, they're waiving their rights," Collyer says.

The main problem with only one person signing the loan is that the bank considers only one income, which is a problem if the higher credit score doesn't match the higher income. Debt-to-income ratio is a major consideration in issuing mortgage loans. Couples may be able to persuade lenders to soften on the debt-to-income ratio issue if they have significant savings -- and by transferring savings from the account of a bad credit spouse into the account of a good credit spouse.

"People don't often associate savings with credit, but you can't have one without the other," says Rod Griffin, director of public education at the credit information company Experian. "If you don't have savings in place to help you through an economic downturn, lenders will be more concerned about that."

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

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