Credit is one of the three main pillars of a mortgage approval.
The other two, income and equity also play just as important of a role as credit but over the years evaluating credit has changed remarkably while income and assets are still documented in the same manner for years.
Not only is credit important as it relates to someone’s likelihood to default on a mortgage but it means not only a determining factor getting an approval but it can even mean saving thousands on your mortgage payment due to a more competitive rate.
Prior to the introduction of credit scoring lenders would evaluate a copy of a printed credit report line by line looking for any late payments and other derogatory information. That took time and once a lender did find some negative information but still figured the loan was worthy of an approval the applicant would still have to write out an explanation letter why there was a late payment on a credit card two years ago. Seriously, that’s the way it worked. Today however, explanation letters are rarely required with the lender paying more attention to the credit score for loan qualification and setting an interest rate.
A Brief History of Credit Repair
Lenders request a special type of credit report called a Residential Mortgage Credit Report from all three main credit repositories, Experian, TransUnion and Equifax. Each bureau provides its own credit report along with an accompanying credit score. Scores used today are based upon an algorithm originally developed by the Fair, Isaac Company which recently officially changed the name to FICO. When a lender pulls a credit report and requests a score, it’s the FICO score that is supplied.
This three digit score can range from 300 to 850 and reflects five facets of an applicant’s credit history-
#1 Payment History
This reflects when payments were made on credit accounts and shows the status of payments made more than 30, 60 and 90 days past the due dates. It also reports any collection accounts or accounts that have been charged off due to non-payment. This is the most important of the five categories representing 35% of the total credit score.
#2 Available Balance
Comprising 30% of the score, this category compares available credit lines with current balances. Credit scores improve when total balances represent 50% or better of the available credit line and most ideally around the 30% mark. If total credit lines add up to $10,000 then scores will improve more rapidly if the balances were closer to $3,000.
#3 Types of Credit
Different types of credit used can help as well as the nature of each credit line. Timely mortgage, credit card and automobile payment help improve a score whereas a loan from a finance company may not. 10% to the total.
#4 Inquiries
This simply means how many times an individual has requested a credit line or a loan. Occasional requests can help a score but multiple, recent requests can actually harm a score, even if no loan was taken out. 10%.
You can easily tell that by concentrating on the first two categories credit scores will rise as they make up nearly two-thirds of the entire score.
#5 A Credit Review
Consumers are well advised to do their own credit check annually on their own just to make sure there are no errors or perhaps instances of fraud on a credit report. Unfortunately mistakes on credit reports is almost legendary and just as unfortunate there are those who do nothing but prey on other people’s credit profiles attempting to not only steal an identity but compromise someone’s credit at the same time.
You can get a copy of your credit report at no charge at each of the three main credit repositories but you can also get a complete copy of all three merged into one report at a website these three agencies sponsor at annualcreditreport.com. Various credit card companies and other consumer sites also provide access to your credit report but going directly to the site sponsored by Experian, TransUnion and Equifax might be the most efficient method.
When reviewing your credit you might be asked if you want to get a copy of your credit score at the same time. Just note however the credit scores consumers can get are different than the one a mortgage lender receives. FICO has credit scores for consumer loans, automobile loans as well as mortgages and they may all be different. Similar perhaps but different.
If you do find mistakes on your report you can contact the three agencies on your own and dispute the errant information. This means you’ll need to document your case and provide it to the agencies that will then contact the creditor and compare the information provided. In the case of identity theft, there are some additional things you’ll need to do if there are credit accounts showing up that you never applied for and didn’t know were there. One of the first things these three credit agencies will ask that you do in the case of fraud is file an official police report and provide it to them. Working on your own correcting mistakes or alerting fraudulent activity can take some time, weeks or more. If you’re applying for a mortgage or getting ready to the time it takes to repair on your own might mean taking longer to be approved for a mortgage while the mistakes are cleared.
LLPA
Lenders have employed a Loan Level Pricing Adjustment, or LLPA for their mortgage loan programs. Be the loan request for a conventional loan of say $400,000 or a jumbo purchase at $1.3 million, lenders can institute their own internal LLPA. This means interest rate adjustments are made based upon a combination of an equity position in a transaction and a credit score. There are other adjustments such as whether or not the property is owner occupied or not, condos and multi-unit properties. Cash out refinance transactions can also have an impact.
When lenders quote an interest rate to you and they have pulled a credit report with the three FICO scores they will throw out the highest and lowest number and use the middle score. If there is more than one borrower, the lender uses the lowest middle score of the two. Now let’s look at a quick example of a sample LLPA that a lender might use on a sales price of $1.2 million and 10% down for a loan amount of $1,080,000.
If someone has a down payment of 10% and a 620 FICO score, the lender may require a 20% down payment instead in order to obtain a loan approval whereas someone with a FICO score of 750 might easily qualify with a 10% down payment. In that same transaction with 10% down, a credit score of 680 might have a slightly higher interest rate compared to someone with a 780 score. If you take a loan amount of $1,080,000 over 30 years at 4.50% for example the monthly payment is $5,472 per month and at 4.75% $5,633. Over the first seven years into the loan the individual with the lower score paid $13,524 more in interest. This can affect not just how much interest is paid to the lender but even obtaining a loan approval at all, even when the required score is 720 and the qualifying score is 715. If the score doesn’t reach the minimum then putting more down might be the only option.
Unless that is if you make some adjustments to your credit balances using Rapid Rescore through your mortgage lender.
Credit Repair: Score Scenarios
Remember that if you work with the credit agencies directly it can take some considerable time along with the frustration working with a customer service person on the other end of a 1-800 number. By working with your loan officer who can order a Rapid Rescore for you while at the same time helping remove derogatory information from your credit report within a matter of 24-72 hours, depending upon the information needing to be changed.
The most efficient way to lower credit scores is to lower current credit balances. You can run different scenarios to see which balances to pay down and then see what the resulting score may be. For example if you have three credit cards each with a balance of $5,000 and your total credit line for all three cards is $16,000 then you have $1,000 of available credit or almost a 94% usage. Now experiment a little and see what happens when you pay your balance down to different levels. In this example if you paid your total balances owed to approximately 30% of your available credit, or $4,800, you can run a “what if” scenario and you can see what that sort of pay down would mean to a credit score. And it only takes a day or two, not one or two months if you worked directly with the credit agencies.
If you do in fact decide to pay down to the ideal level, you would make the payments then the loan officer would run a Rapid Rescore for you. This completely eliminates the lower scores and your credit report is provided with a fresh new set of improved scores.
The same can be done with collection accounts with a little bit of cooperation from the creditor. Let’s say there is a collection account showing up that you didn’t know about. You contact the creditor to get a payoff amount but you must also ask for a “deletion” letter from them. If you get this letter upfront and then pay off the balance, the collection account will disappear and Rapid Rescore will again provide new scores. A Rapid Rescore can be performed on any or all of the three scores. That of course means that if you have three scores and your middle one is holding you back, you can do a rescore on just the middle one and leave the other two alone. Most however decide to correct the information from all three bureaus because each of these agencies regularly review credit histories and the previously corrected information can suddenly pop up again in the future.
And one of the more common of errors found on credit reports are the ones resulting from medical bills. For any of us who have had the unfortunate experience of having to go to a hospital for a few days to recover from an illness or injury know far too well how confusing the billing process can be. There are deductibles to be met and multiple parties must be paid. It’s hard to know who to pay and who not to pay and it’s common for someone to be paid twice and as well as not paying someone you thought was paid by the insurance company.
Scoring Evolution
Currently, mortgage lenders are beginning to use the ninth version of FICO, or FICO 9 yet many are still using the previous version. Scores change over the course of a few years as tweaks are made to more truly reflect an individual’s credit history. For example, paying off a medical collection account actually helps a score where previously paying off a medical collection account would hurt a score because the account reflected more recent activity and with medical collections being so common as well as confusing medical collections had its own status and now FICO 9 doesn’t lower a score just because a medical collection account was paid off. That didn’t make sense otherwise.
Indeed, recent changes also reward someone who pays off a valid collection account regardless of the type. For years more emphasis was placed on the most recent activity of the delinquent account regardless of what the activity actually was. In this example it’s someone who takes responsibility for the old debt and pays it off.
One important note to understand about credit scores- they’re not necessarily universal. Lenders, especially jumbo lenders are more likely to have their own LLPA compared to a mortgage approved using conventional lending guidelines established by Fannie Mae and a loan amount at or below the conforming loan limit.
This also means that while lenders typically don’t accept lower scores than what Fannie requires they can boost their own score requirements. If one lender has a 740 score requirement for a loan another lender can require a 750 under the very same scenario as long as the lender applies the scoring requirements universally among all applicants.
Getting Rescored To See If You Have Repaired Your Credit…
If there is anything you should take away from this paper regarding credit scores it’s the importance of working with your loan officer during this entire process. Mortgage lenders have established business relationships with credit reporting agencies and have access to certain tools the everyday consumer simply doesn’t have.
If you have a credit report with errors or a report that needs some improvement talk with a loan officer first before you get too much further. There are various “what if” calculators that can run some scenarios to reach a particular score but if paying down credit accounts is the obvious way to go, don’t empty your cash accounts to pay down credit lines when paying less would achieve the same result.
An experienced loan officer who has been in the business for say 10 years or more has very likely seen more than a thousand credit reports of all types and knows what tasks need to be done to most effectively arrive at the credit score you really want.
