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The average borrower’s credit score trended down in May, led by a significant drop in cash-out refinance scores — a move attributed to higher-credit borrowers exiting the cash-out refi pool over the past two years.

Average credit scores for cash-out refis came in at 698 last month, dropping seven points in the last three months and 33 points year over year, according to Black Knight‘s originations report released Monday. Meanwhile, average credit scores for purchase locks fell marginally by two points to 732 and rate/term refinance dropped by one point to 731 in May from the previous month. 

“It’s historically typical behavior for high credit score borrowers to exit the refi market when rates rise; we’ve seen it time and again,” Andy Walden, vice president of enterprise research at Black Knight told HousingWire. “When the higher scored borrowers leave the total pool, it results in lower overall credit scores among refinance transactions.”

Riskier lending habits and borrowing options led to the housing crash 15 years ago, but Black Knight said credit scores for purchase locks have held strong and the average current credit score of 751 for existing mortgage holders is the highest dating back to 2000. 

The drop in credit scores may indicate borrowers are shifting toward home equity line of credit (HELOCs) and second lien home equity loans, which have tighter lending standards, Walden said, adding: “Those high credit borrowers who qualify may be moving to those products while those with lower credit scores may not qualify and may be utilizing cash-out refinances to access equity.”

A brokerage owner in Brooklyn, Kevin Leibowitz, said he hasn’t seen enough lenders expand the credit box to get more borrowers, but he expects loans will be loosely underwritten compared to two years ago. 

“Lenders are finally getting to the difficult loans and difficult loan-profile (non-standard income) borrowers that weren’t getting ample love during the refi boom,” Leibowitz, president of Grayton Mortgage, said. “Your average refinance would probably look riskier because if they didn’t refinance two years ago, why are they refinancing now?”

With refi volume lower this year by more than 70% from 2021, “lenders are opening the credit box to more riskier borrowers,” Selma Happ, deputy chief economist at CoreLogic, told HousingWire. 

It’s worth monitoring the trends with credit scores, but equity gains homeowners saw over the past two years are a good buffer for riskier loans, Happ added. An average borrower has seen a gain of $63,000 in the first quarter of this year, a 32% increase year over year, according to CoreLogic’s report. 

The borrower’s credit score does not reflect everything about the health of the mortgage market, Leibowitz said, adding: “What would be concerning is when the loan-to-value (LTV) is going up.” 

A high LTV means more risk because if a borrower defaults on a loan, it’s less likely that the lender will get enough money by processing and selling the asset to cover the remaining loan amount and the costs associated with the process.