Tuesday, December 12, 2006 - Article by: Lender411 Member
Nearly every time I run someone's credit, I get asked questions like "will running my credit HURT my credit score?" or "how can I fix my credit?"
Your credit score is the single biggest factor in getting a new home loan. If your score is above 720, you can possibly qualify for a $1 million home with very little money down. If your score is below 500 and you have $1 million in the bank, you may have trouble qualifying for this exact same home. Your interest rate will certainly be different.
Credit scores are central to the loan process. Nearly every lender uses them. The better your credit, the lower the risk to the bank, the lower your interest rate.
Most lenders use your FICO score to determine whether or not you qualify for a home. It's such an important issue that you and your clients should understand the basics of the credit reporting system and the many myths surrounding it.
Credit scores give lenders a fast, objective and impartial snapshot of a person's credit risk based on their credit history.
That's why lenders use FICO credit scores when making credit decisions. The higher the individual's score, the lower the risk to lenders when extending new credit to that person. Its fast, easy, and, usually, effective.
ABOUT YOUR FICO SCORE
Think about your credit report as a story about your financial life, as told through your credit history. This has nothing to do with you personally. Everything is there from the first credit card you got out of high school to your cell phones to your most recent mortgage. It all has a very telling payment history. Some of it is good and some of it maybe not-so-good. Regardless, it tells a lender what he needs to know about you. It tells the lender how committed you have been, historically, to paying your bills, both big and small, on time.
It simply tells us how risky it is to loan you money.
A FICO score is a credit score developed by Fair Isaac & Co. Credit scoring. It is a method of determining the likelihood that credit users will pay their bills. It helps lenders determine the "risk" in granting you a loan.
This method has become widely accepted by lenders as a reliable means of credit evaluation. A credit score attempts to condense a borrower's credit history into a single number. Fair, Isaac & Co. and the credit bureaus do not reveal how these scores are computed and The Federal Trade Commission has ruled this to be acceptable.
Credit scores are calculated by using scoring models and mathematical tables that assign points for different pieces of information which best predict future credit performance. It basically gives us a risk rating today of how likely you are, compared to the rest of the people in the U.S., of paying your bills tomorrow.
Credit scores measure the likelihood of default, so credit scores are generated using factors that have been found to predict credit risk. These factors are not weighted evenly and several minor instances may indicate a higher risk than one major, but isolated, credit problem.
There are five main categories of credit information which impact your credit score:
1. Late payments, delinquencies, bankruptcies: Past inability to pay on time will hurt your chances of getting credit in the future. More recent problems will be counted more heavily than those in the past.
2. Outstanding debt: The more debt one has, the greater the risk that he or she will not be able to keep up with the payments
3. Length of credit history: With a short track record it is harder for a lender to assess creditworthiness
4. New applications for credit (inquiries): Frequent credit checks by lenders may indicate that a borrower is looking to increase his or her amount of debt.
5. Types of credit in use: Some types of credit, including credit cards, provide you with a credit line greater than the amount you have already borrowed. The more credit available, the greater the risk to the lender since a borrower can easily increase their outstanding debt.
There are really three FICO scores computed by data provided by each of the three major bureaus--Experian, Trans Union and Equifax.
Most lenders use the middle of these three scores. For example, if Experian gave you a 689, Trans Union 704, and Equifax 696, we would throw out the top score (Trans Union 704), throw out the bottom score (Experian 689) and use the middle score of 696 from Equifax.
Your FICO score for the purposes of our loan would be 696.
The bureaus don't all share the same data and thus all have different scores . One bureau may list more accounts for you than another, for example, and the differences (in types of accounts, payment histories, credit limits and balances) will be reflected in the score that bureau computes for you.
Because of those differences, it makes sense to pull and examine your credit reports from all three bureaus before you apply for a mortgage. Fixing errors in all three reports before you shop for a loan is smart. We will discuss how to get a copy of your credit report and how to fix it later in this newsletter.
Here are the most frequently asked questions about credit reports:
WHAT IS A GOOD CREDIT SCORE?
Credit scores generally range from the mid-300's to a perfect score of 850.
The following will give you a general idea of what your score tells lenders, but remember there are no set rules. Different products and lenders use different guidelines for what is an acceptable score.
Also, there will usually be differences in the scores calculated by each of the three credit bureaus. As stated, lenders will often use the middle of your three scores.
720+ = Excellent credit. You should have no problems as most loan programs will be available to you.
680 - 719 = Good credit. You should have few problems depending on what product you seek.
620 - 679 = Lender has to take a closer look at your file but should be able to qualify you for a loan. Some products may not be available.
570 - 619 = Higher risk; you will not be eligible for the best rates and products. Products will be limited.
Below 570 = Very high risk. Products will be limited and other factors will need to be considered.
The average person in the U.S. has a credit score around 675. As you can see on the list above, the average borrower's file needs a "closer look" and is not a "slam-dunk."
HOW DOES MY SCORE AFFECT MY INTEREST RATE?
The better your score, the lower the risk to the lender, the lower your interest rate.
Let's say that John Doe is buying a new house for $300,000. He is employed, can document his income through his tax returns, and has enough funds verified in the bank to put 20% down on the purchase of his new $300,000 home. He wants a 30-year fixed mortgage.
Below you will find an example of how Mr. Doe's interest rate may fluctuate based on his credit score.
MID-FICO: INTEREST RATE:
This is a primary example of why when you ask your lender, "what is the rate today?" the answer is not simple unless they know the credit score and financial profile of the borrower. Rates change based primarily on credit scores, use (owner-occupied vs. investment), income documentation, down payment, and availability of funds.
WHAT FACTORS MAKE UP MY SCORE?
Some of the factors considered in credit scores:
o Recent or serious derogatory public record or collection
o Past due balances
o Account payment or credit history not long enough
o Lack of recent information on accounts
o Insufficient number of satisfactory accounts
o Date of last credit too recent
o Too few or no recent balances on revolving accounts (e.g. credit cards)
Factors correlated with higher risk:
o Excessive amount owed on accounts
o Proportion of loan balances on installment accounts
o Too many new or existing accounts
o Too many recent credit checks
o Proportion of revolving balances to revolving credit limits is too high (e.g. credit card balance vs. limit)
Factors not considered in credit scores
o National origin
o Receipt of public assistance
o Inquiries made by companies for promotional or account monitoring purposes (credit card companies, where you have accounts, often run your credit to make sure your situation has not dramatically changed)
DOES MY CREDIT SCORE GO DOWN EVERY TIME IT IS CHECKED?
If you do all your shopping around in a short period, and it is focused on just getting a new home loan, then the answer is "no".
Credit inquiries are a negative factor in determining credit scores. That's because statistical studies show that multiple inquiries are associated with high risk of default. Distressed borrowers often contact many lenders hoping to find one who will approve them.
Multiple inquiries can also result from applicants shopping for the best deal. The credit bureaus understand this and do not penalize you for it.
Credit scorers usually ignore inquiries, from a same industry, that occur within 30 days of a score date. Suppose I shopped a lender on May 30, for example, and the lender has my credit scored that day. Even if I had shopped 50 other lenders in May and they had all checked my credit, none of those inquiries would affect my credit score on May 30.
Now, if you are also shopping for a new car, a new big screen TV, and applying for new credit cards during this same period, yes, that will create negativity on your credit report.
Remember, this score is assessing the "risk" in giving you a new loan. If you are contacting may different types of lenders for many different products, you are giving the appearance of extending your credit our further and that makes you more risky.
Didn't find the answer you wanted? Ask one of your own.