In the old days, mortgage lenders judged the credit worthiness of a borrower by closely studying credit reports in order to understand the nuances and the “story” behind the score. In today’s fast-paced, impersonal lending world, mortgage lenders spend less time studying a credit report and more time relying credit scores.
Unfortunately, since home loan lenders increasingly eschew thorough credit report analysis, depending instead on scores alone, home mortgage borrowers must ensure not only to build and maintain good credit, but also to monitor credit reports for errors.
Your credit report most likely contains errors. Two categories of errors exist: commission (information that appears on your credit report even though it should not); and, omission (information that does not appear on your credit report even though it should). Either way, errors can and often do hurt your credit score.
Lenders very often report erroneous information to the three credit reporting bureaus: Equifax, Experian and Trans Union. Many of these errors can plummet a borrower’s credit score and preclude them from obtaining home mortgages. While most reporting errors by lenders occur due to carelessness, confusion, or negligence, sometimes lenders intentionally report erroneous information. Some lenders, for example, have been known deliberately to omit reporting maximum credit limits or timely payments in order to stop their customers’ credit scores from rising and thus, stop customers from changing to lower cost lenders who serve higher credit quality clients.
Aside from the lenders, the credit bureaus themselves also commit mistakes. Credit bureaus gain no benefit from errors; however, like any business, the credit bureaus attempt to increase profits by lowering costs. The cheapest management of their gigantic databases comprises the bureaus’ main cost cutting strategy. As most consumers know, you often get what you pay for. The lower the cost of managing data, the less accurate those data become.
The Common Name Game
While having a common name such as Richard Smith has probably helped you remain anonymous and difficult to find on Facebook, it has probably also cost you a lower credit score. Common names possess a higher probability of credit reporting error. Lenders and credit bureaus very often insert information into your file that pertains to others with your name (and vice versa).
The Credit Score Numbers
FICO scores range from 350 (lowest) to 850 (highest). The median FICO score is 715. Twenty percent of the population maintains a FICO score higher than 780 while 20 percent of the population maintains a FICO score lower than 620.
Generally, borrowers must maintain at least a 740 FICO score in order to qualify for the lowest rate home mortgages, second mortgages, home refinancing loan or home equity loan or line of credit. Borrowers with this excellent credit rating will find mortgages and other home loan products that charge lower than prime rate. This FICO score requirement can increase or decrease depending upon market conditions.
Borrowers with FICO scores lower than 620 will find it very difficult to gain approval for any home loan program. Borrowers with FICO scores in the 620 to 659 range will find home loan financing at sub-prime rates. This means that their mortgage, home mortgage, second mortgage, home refinancing loan or home equity loan will cost more than the prime rate. Borrowers with FICO scores in the 660 to 720 range will be offered home loans at prime rate.
How the Numbers Are Calculated
Two major factors comprise approximately two thirds of your FICO score: payment history and total debt owed. FICO credit analysts like to check whether or not a borrower lives beyond his or her means (because no one wants to lend to a borrower on the edge). They determine this by comparing the amount of debt owed on an account to the total credit limit on the account. They call this measure a credit “utilization rate”.
For example, if a borrower has a Visa card with a $20,000 total credit limit and has used $10,000 of that limit, then the utilization rate for that account is 50 percent.
Utilization rates and FICO scores move in opposite directions. Higher utilization rates trigger lower FICO scores and vice versa.
As mentioned earlier, creditors often misreport credit balances. Even more troubling, creditors often misreport or fail to report credit limits. If a creditor does not report a maximum credit limit, then the credit bureaus will assume that the largest historical reported balance on that credit line is the limit. This often underreports a borrower’s credit maximum, thus over calculating the borrower’s utilization rate and lowering his or her FICO score.
Before beginning to shop for any home mortgage, home equity line of credit, home improvement loan, second mortgage or home mortgage refinance, consumers should check the reported balances and credit limits on their credit reports. For any accounts with unreported limits, borrowers should immediately request that the creditor report the limit (and threaten to end the relationship if the creditor does not comply)! If the credit fails to comply but the borrower needs or wants to continue the credit relationship, then the borrower should temporarily transfer balances to this account in order to increase the reported/assumed maximum credit line on the credit report. After the bureaus assume this new maximum, quickly move the balances off to another account in order to decrease the utilization rate.
FICO Scores and Mortgage Rates
The below chart offers an example of the home mortgage rates offered to borrowers in the different FICO score tiers.
Average Mortgage Rates in
Los Angeles County by FICO Score
The percentage rates may not differ too significantly; however, you should remember that home mortgage interest rates determine mortgage payments. For example, let’s assume that a borrower would like to buy a $300,000 home. This buyer will make a down payment of 20 percent, and will finance the remainder with 30 year fixed rate mortgage. A borrower with a fair credit rating can expect a monthly payment of $1,288, while a borrower with a good credit rating can expect a monthly payment of $1,251, while a borrower with an excellent credit rating can expect a monthly payment of $1,198.
Alternative Credit Scoring Numbers
In 2006, the three credit bureaus, Equifax, Experian and Trans Union, established their own credit scoring system, which they called VantageScore, to compete with the traditional FICO. This new system, VantageScore, employs a 1,000 point scale. This system functions much like scholastic scores: a 900-1,000 score is an “A” credit, while an 800-900 score represents a “B” credit etc. Borrowers should be careful not to confuse the two scoring systems as a 750 FICO score comprises an “A” credit while a 750 VantageScore comprises a “C” credit.
Time Heals All Wounds
The Federal Fair Credit Reporting Act limits the length of time that negative information can appear on a consumer’s credit report. A negative data point should delete after the limited time period that corresponds to its category elapses. Once a data point deletes from a credit report, it can no longer hurt a consumer.
The categories and their time limits include: mortgage foreclosure, late payments, collection accounts and chapter 13 bankruptcy, seven years; inquiries from credit grantors, two years; chapter 7 bankruptcy, 10 years; unpaid tax liens, forever.
While seven years may seem like a long time, you should remember that even before negative information deletes from your credit report, it will weigh less and less on your credit score as it ages. Even more important to remember, however, borrowers must generate new positive credit information (such as on-time payments) in order to increase a credit score. Aging negative information followed by no new information will cause a continued low credit score.
Be careful of delinquencies, they remain on your credit report for seven years even if you later pay them off (although, as mentioned above, they weigh less as time passes). Officially, only payments 30 or more days past due are considered delinquent. Do not confuse late payments with delinquent payments. Late payments are those received after the grace period granted by the lender. For example, if a mortgage payment is due on the fourth of a month and the borrower pays on the 23rd of a month, the borrower will not receive a delinquency on his or her credit report. Such a payment is only considered late and, as such, will incur a late charge with no credit report impact.
Never ever skip a mortgage payment! One single skipped mortgage payment can tip the dominoes of delinquency. Lenders credit mortgage payments against the earliest unpaid payment. Thus, if you skip a mortgage payment in June, your lender will report a delinquency. You might think you can remedy this by paying in July, however, the July payment will be applied to the June unpaid balance, meaning that you will now be delinquent for July as well. Your August payment will apply to your July payment, meaning that now you are delinquent for August. The delinquency continues on this train until you finally make two payments in one month in order to cover the current month and the forward moving delinquency.
Credit inquiries also hurt credit scores. Apparently, cash strapped borrowers about to default try frantically to find new debt. However, home and car buyers shopping for good mortgage deals also generate multiple inquiries. In order to protect consumers in this situation, credit scorers ignore auto and mortgage inquiries that occur within 30 days of a score date. Also, in order to protect consumers who have shopped in the past, scorers treat all mortgage loan and car loan inquiries that occur within a 14-day period as if they were one single inquiry.
Be Proactive and Improve Your Credit Score
Pay all of your bills on time. If you face financial trouble, contact your creditors and attempt to arrange for them to lower your payments.
Keep credit card balances as low as you can. High revolving credit balances negatively affect FICO scores. Ideally, revolving credit accounts should maintain two thirds of their availability. So, if you have a $10,000 credit card, attempt to pay it down to approximately $3,000. If you cannot, then find a card with unused balance and transfer a portion to that card so that the two the cards maintain unused balances.
Try not to open new accounts. The opening of new accounts reduces FICO scores. Also, try not to close old accounts as the more established accounts reflect favorably and tend to raise FICO scores.
Check your credit reports. Several companies offer introductory free reports followed by low cost quarterly or monthly reports. Read the reports carefully and note late payments. Write the credit bureaus with a request to delete each piece of negative information. Your credit reports will include instructions on how to write the bureaus in order to dispute information.