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FICO Scores and Your
Mortgage
Three years ago, credit scoring had
little to do with mortgage lending . When reviewing the credit worthiness
of a borrower, an underwriter would make a subjective decision based on
past payment history.
Then things changed.
Lenders studied
the relationship between credit scores and mortgage delinquencies. There
was a definite relationship. Almost half of those borrowers with FICO
scores below 550 became ninety days delinquent at least once during their
mortgage. On the other hand, only two out of every 10,000 borrowers with
FICO scores above eight hundred became delinquent.
So lenders
began to take a closer look at FICO scores and this is what they found
out. The chart below shows the likelihood of a ninety day delinquency for
specific FICO scores.
FICO Score Odds of a Delinquent Account
============ ============================
595 2 to 1
600 4 to 1
615 9 to 1
630 18 to 1
645 36 to 1
660 72 to 1
680 144 to 1
780 576 to 1
If you were lending a couple hundred thousand dollars,
who would you want to lend it to?
FICO Scores, What Affects
Them, How Lenders Look At Them
Imagine a busy lending office
and a loan officer has just ordered a credit report. He hears the whir of
the laser printer and he knows the pages of the credit report are going to
start spitting out in just a second. There is a moment of tension in the
air. He watches the pages stack up in the collection tray, but he waits to
pick them up until all of the pages are finished printing. He waits
because FICO scores are located at the end of the report. Previously, he
would have probably picked them up as they came off. A FICO above 700 will
evoke a smile, then a grin, perhaps a shout and a "victory" style arm pump
in the air. A score below 600 will definitely result in a frown, a
furrowed brow, and concern.
FICO stands for Fair Isaac &
Company, and credit scores are reported by each of the three major credit
bureaus: TRW (Experian), Equifax, and Trans-Union. The score does not come
up exactly the same on each bureau because each bureau places a slightly
different emphasis on different items. Scores range from 365 to 840.
Some of the things that affect your FICO scores:
- Delinquencies
- Too many accounts opened within the last twelve months
- Short credit history
- Balances on revolving credit are near the maximum limits
- Public records, such as tax liens, judgments, or bankruptcies
- No recent credit card balances
- Too many recent credit inquiries
- Too few revolving accounts
- Too many revolving accounts
Sounds confusing,
doesn't it?
The credit score is actually calculated using a
"scorecard" where you receive points for certain things. Creditors and
lenders who view your credit report do not get to see the scorecard, so
they do not know exactly how your score was calculated. They just see the
final scores.
Basic guidelines on how to view the FICO scores vary
a little from lender to lender. Usually, a score above 680 will require a
very basic review of the entire loan package. Scores between 640 and 680
require more thorough underwriting. Once a score gets below 640, an
underwriter will look at a loan application with a more cautious approach.
Many lenders will not even consider a loan with a FICO score below 600,
some as high as 620.
FICO Scores and Interest Rates
Credit scores can affect more than whether your loan gets approved
or not. They can also affect how much you pay for your loan, too. Some
lenders establish a "base price" and will reduce the points on a loan if
the credit score is above a certain level. For example, one major national
lender reduces the cost of a loan by a quarter point if the FICO score is
greater than 725. If it is between 700 and 724, they will reduce the cost
by one-eighth of a point. A point is equal to one percent of the loan
amount.
There are other lenders who do it in reverse. They
establish their base price, but instead of reducing the cost for good FICO
scores, they "add on" costs for lower FICO scores. The results from either
method would work out to be approximately the same interest rate. It is
just that the second way "looks" better when you are quoting interest
rates on a rate sheet or in an advertisement.
--FICO Scores and
Mortgage Underwriting Decisions --
FICO Scores as
Guidelines
FICO scores are only "guidelines" and factors other
than FICO scores affect underwriting decisions. Some examples of
compensating factors that will make an underwriter more lenient toward
lower FICO scores can be a larger down payment, low debt-to-income ratios,
an excellent history of saving money, and others. There also may be a
reasonable explanation for items on the credit history which negatively
impact your credit score.
They Don't Always Make Sense
Even so, sometimes credit scores do not seem to make any sense at
all. One borrower with a completely flawless credit history had a FICO
score below 600. One borrower with a foreclosure on her credit report had
a FICO above 780.
Portfolio & Sub-Prime Lenders
Finally, there are a few "portfolio" lenders who do not even look
at credit scoring, at least on their portfolio loans. A portfolio lender
is usually a savings & loan institution who originates some adjustable
rate mortgages that they intend to keep in their own portfolio instead of
selling them in the secondary mortgage market. They may look at home loans
differently. Some concentrate on the value of the home. Some may
concentrate more on the savings history of the borrower. There are also
"sub-prime" lenders, or "B & C paper" lenders, who will provide a home
loan, but at a higher interest rate and cost.
Running Credit
Reports
One thing to remember when you are shopping for a home
loan is that you should not let numerous mortgage lenders run credit
reports on you. Wait until you have a reasonable expectation that they are
the lender you are going to use to obtain your home loan. Not only will
you have to explain any credit inquiries in the last ninety days, but
numerous inquiries will lower your FICO score by a small amount. This may
not matter if your FICO is 780, but it would matter to you if it is 642.
Don't Buy A Car Just Before Looking for a Home!
In
conclusion, a word of advice not directly related to FICO scores. When
people begin to think about the possibility of buying a home, they often
think about buying other big ticket items, such as cars. Quite often when
someone asks a lender to pre-qualify them for a home loan there is a brand
new car payment on the credit report. Often, they would have qualified in
their anticipated price range except that the new car payment has raised
their debt-to-income ratio, lowering their maximum purchase price.
Sometimes they have bought the car so recently that the new loan doesn't
even show up on the credit report yet, but with six to eight credit
inquiries from car dealers and automobile finance companies it is kind of
obvious. Almost every time you sit down in a car dealership, it generates
two inquiries into your credit.
Credit History is Important
Nowadays, credit scores are important if you want to get the best
interest rate available. Protect your FICO score. Do not open new
revolving accounts needlessly. Do not fill out credit applications
needlessly. Do not keep your credit cards nearly maxed out. Make sure you
do use your credit occasionally. Always make sure every creditor has their
payment in their office no later than 29 days past due.
And
never ever be more than thirty days late on your mortgage. Ever.
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