Why are credit scores so important in the US compared to Europe?

Question

Back when I lived in Central Europe, most loans/mortgages only depended on your current income and employment history. If you held on to a good job for several years, you could well expect to get a mortgage without issues, even if you've never owned a credit card in your life. But in the US it seems that banks trust credit ratings a lot more and simply having a job is not sufficient to get a loan if you've never bothered to build up a credit history.

Why is this the case? Why is credit history more important than income to American lenders?

Answer 1

Why is credit history more important than income to American lenders?

It's not. Income is important to the underwriting process for larger loans like a mortgage.

I don't know how prevalent this practice is in Europe but in the US our lending market shifted such that it's uncommon for the organization "originating" a loan to actually keep and service the loan. It is very common for Organization A to issue a loan and charge a fee for doing so then almost immediately sell the loan Organization B.

In this originate and sell model the origination criteria conforms to the buying criteria of the downstream loan buying organizations. That may include credit scores between 700 and 750 or some such other criteria. Meaning, if the market of loan buyers like Organization B is only really hungry for loans where the borrower has at least a 700 or better credit score, the originators won't write loans where the borrowers score is lower. But there's no body on the planet with a credit score of 820 getting a $300,000 mortgage against zero income. So it would be wrong to say income doesn't matter.

My personal feeling is that the "importance" of credit score is blown way out of proportion.

Answer 2

Credit history/score isn't the most important factor.

Back when I lived in Central Europe, most loans/mortgages only depended on your current income and employment history. If you held on to a good job for several years, you could well expect to get a mortgage without issues, even if you've never owned a credit card in your life.

There are programs in the US for first time homeowners. My state has programs for people that never have never owned a home, or have a low credit score, or a thin credit file, or have low income. They help with down payments, lower interest rates, and extra tax credits. These programs have existed for decades.

Lenders are looking for three things:

• do you have enough income/resources to afford the payments.
• based on your current obligations can you afford the payments.
• does your credit history/score show a history of missing payments.

The first two can be calculated easily and then applied against lenders guidelines.

The third is the complex part. It is possible that the risks associated with a low score change the interest rate being offered, thus making the loan unaffordable.

That is where these government programs come in. They can lower rates, or provide down payments. Thus reducing the risk to the lender. Similar programs are also used to provide loan opportunities for students.