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Lessons from a Lender: Credit Score Advice
Written by Don Frutchey of Atlantic Coast Mortgage LLC
One of the most important aspects in the “underwriting triangle” is the credit score. Not only is credit elemental to the loan approval but also has an impact on the monthly payment. Of the three critical underwriting elements and aside from the down payment, credit (typically calculated using the FICO scoring models) is the only one for which pricing adjustments are made as the variable changes. As an example, for a purchase using 20% down payment the difference in a mortgage rate quoted for a borrower with a 640 credit score vs. one with a 740 credit score can be as much as 5/8 of a percent in rate. This equates to nearly $38/month per $100,000 in loan amount, and also close to $13,000 in extra interest paid per $100,000 in loan amount.
The underwriting triangle also consists of income and assets. As opposed to the credit score, a borrower would not be rewarded for a higher income relative to a loan amount. Nor would they be punished for a lower income. Likewise, if a home buyer has many thousands of dollars in the bank covering a longer than normal payment reserve period (the number of months a mortgage payment could be covered if the borrower suffered a job loss), would not benefit in the form of a lower interest rate. Given this, a credit score for a home purchase can mean affordability versus ”no way can we afford this!”. When beginning a loan pre-approval
When beginning a loan pre-approval process I will, with the client’s permission, pull a residential mortgage credit report (RMCR). This gathers data from the three trade bureaus and summarizes in an easy to read format. Highlighted factors include credit scores from each of the three trade bureaus (Equifax, Experian, and Trans Union), payment history, credit utilization, high balances, credit limits, minimum monthly payments, creditors, judgments, collections, tax liens, and much more. This can be different than a consumer report, sometimes significantly altering the scores seen between those free reports and those run by mortgage professionals. The scoring algorithms are also tweaked to suit the individual bureaus preferences. Due to this scores will very rarely be the same for all three.
The payment history accounts for approximately 35% of total weight when calculating the FICO score. The longer a consumer has been paying on time for the credit lines the higher your score will be. Note that a payment is not generally reported as late to the bureaus unless it is 30 days late. This means that although you pay a penalty for being five days – or 29 days – late, the credit score sill not be impacted by the late payment. The payment history also includes other derogatory items such as collection accounts, tax liens, and judgments. I have seen more traffic tickets that turn in to long time collections than I can remember. Throwing the ticket in the trash will not make it go away! Municipalities have systems and means to easily report these non-payments to the credit bureaus and absolutely trash a credit report. And this goes for phone, cable, condo dues and everything that one would just assume forget about. Just because the creditors aren’t knocking at the door does not mean they have let go of it. Pay those bills!
30% of the FICO score weight is related to the total amount that is owed. This will include the balances, the number of accounts with balances and your credit limits. I suggest that people limit the number of open accounts to between four and six (including credit cards, store cards, auto payments and student loans) and try to keep the balances on the variable accounts (cards) to 30% of the available credit. For many individuals, particularly those with student loans, this is impossible. Unfortunately, a higher number of accounts will have a negative impact on the scores but this will be mitigated somewhat by a longer length of on time payment history.
Next, 15% of the score relates to the aforementioned length of credit history. Longer histories will have higher scores. However, with responsible credit management, this factor can be positive for those with shorter histories as well. More so when beginning to build credit, on time payments will be critical for those with shorter history.
A 10% factor is assigned to new credit that is applied for. You will have a period of time in which you can shop for a home loan without it affecting your credit more so than if it had been pulled only once. I suggest limiting your search to a two week period to avoid unnecessary hits to your credit. Each pull outside of this period (over and above the original pull) can lower your credit scores between 3-5 points. If you have excellent credit this will not matter, but given that there are pricing adjustments related to rates at 20 point intervals it is important to remember for those that might not have stellar credit.
Lastly, other factors such as credit mix have a 10% factor in the credit score. Too many store credit cards could signal problems and is reflected as such.
All of the information above comes straight from myFICO.com as well as the three trade bureaus in addition to my experience as a loan officer in the trenches since 2002. Anyone contemplating a home purchase would be wise to begin by analyzing their credit report. Certainly start with one of the free reports offered by the three trade bureaus, but don’t take this as the last stop. As mentioned, these reports don’t catch everything and certainly have different ways of calculating the credit score. Call or visit a qualified mortgage professional to run an RMCR and review the data before making any changes. Do NOT make changes before a consultation – closing the wrong account may send your score the opposite direction. This service should be free – mine is!
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