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Many homebuyers wonder how their credit report will affect their ability to qualify for a home loan. Rumors abound about the unfortunate soul who received a $5 parking ticket and couldn't qualify for a mortgage because of it.
Of course, that could never happen. Most people don't need to worry about their credit history during the mortgage process. However, it's often helpful to request and review a copy of your credit report before you apply for your mortgage. That way, if there are any errors you can take steps to correct them before you make your application.
If you have had credit problems
, be prepared to discuss them honestly with a mortgage professional and provide a written explanation. Responsible mortgage professionals know there can be legitimate reasons for credit problems, such as unemployment, illness or other financial difficulties. If you had a problem that's been corrected, and your payments have been on time for a year or more, your credit may be considered satisfactory.
ABC's of Mortgage Credit
The mortgage industry tends to use its own language. Credit rating is no exception. "BC" mortgage lending (also known as "hard money") gets its name from the grading of one's credit report. An abundance of derogatory credit is termed "B" or "C" credit, depending on the extent of late payments and other credit problems. Grading is based on factors such as payment history, amount of debt payments, bankruptcies, equity position, credit scores, etc.
We have compiled a guide to help you estimate your credit grade. This is only a guide and each loan application is underwritten and approved on it own merits with many factors other than credit taken into consideration.
General Guide to Credit Scores
Your credit grade and credit score will help determine the highest Loan-to-Value percentage a mortgage broker will be willing to lend you.
Grade Score Loan-to-Value (LTV)
A+ 700 100%
A- 660 95%
B 620 85%
C 580 75%
D 550 60%
E 520 65%
Your record of bankruptcies and foreclosures will also help determine your credit rating.
Grade Bankruptcy/Foreclosure Record
A+ None Allowed Within 10 years
A- Minimum 2 Years, Re-Established Credit
B Minimum 2 Years, Some Late Payments
C Mimimun 1 Year
D Discharged
E Possible Current
The ratings shown here are estimates. When trying to figure your credit grade, keep in mind the following principles:
*Other Things Being Equal - When you have derogatory credit, all of the other aspects of the loan need to be in order. Equity, stability, income, documentation, assets, etc. play a larger role in the approval decision.
*Worst Case Scenario - When determining your grade, various combinations are allowed, but the worst case will push your grade to a lower credit guide. Mortgage late payments and bankruptcies are the most important credit factors.
*Going Once, Going Twice - Credit patterns are very important. A high number of recent inquiries and more than a few outstanding loans may signal a problem. A "willingness to pay" is important, thus late payments in the same time period are better than random late payments as they signal an effort to pay even after falling behind.
Credit Scoring
In a nutshell, credit scoring is a statistical method of assessing a loan applicant's credit risk. The score is a number that rates the likelihood of an individual repaying a loan. The score considers the following items: past delinquencies, derogatory payment behavior, current debt level, length of credit history, types of credit, and number of inquiries.
Credit scoring will place borrowers in one of three general categories.
* First, a borrower with a score 680 and above may be considered an A+ borrower. The loan will involve basic underwriting, probably through a "computerized automated underwriting" system and be completed within minutes. Borrowers falling into this category have a good chance of obtaining a lower interest rate and closing their loan within a couple of days.
* With a score below 680 but above 620, underwriters will probably take a closer look at the file in determining potential risks. Supplemental credit documentation and letters of explanation may be required before an underwriting decision is made. Loans within this FICO scoring range may allow borrowers to obtain "A" pricing, but loan closing may still take several days or weeks.
* Third, borrowers with a score below 620 may find themselves unable to qualify for the best loan rates and terms offered. Mortgage professionals may divert these borrowers to alternate funding sources other than FNMA and FHLMC. Borrowers may find the loan terms and conditions less attractive than the "A" loans, and it may take some time before a suitable funding source is located.
As more companies utilize credit scoring, the loan approval and closing time will be compressed for most consumers. In the future, a high FICO score may be your ticket to a speedy and competitively priced mortgage loan.
Credit Reporting Agencies
Equifax
PO Box 105873
Atlanta, GA 30348
(800) 685-1111
Experian
PO Box 8030
Layton, UT 84041-8030
(800) 520-1221
(800) 682-7654
Trans-Union
PO Box 390
Springfield, PA 19064
(800) 916-8800
(800) 851-2674
How to Correct Credit Errors
You have the right, under the Fair Credit Reporting Act, to dispute the accuracy of information in your credit file. When a credit reporting agency receives a dispute, it must reinvestigate and record the current status of the disputed items within a "reasonable period of time," unless the dispute is believed to be "frivolous or irrelevant." If the credit-reporting agency cannot verify a disputed item, it must delete it. If your report contains erroneous information, the credit-reporting agency must correct it. If an item is incomplete, the credit-reporting agency must complete it.
For example, if your file showed you were late in making payments on accounts, but failed to show you were no longer delinquent, the credit reporting agency must show your payments are now current. Or if your file showed an account that belongs to another person, the credit reporting agency would have to delete it. Also, at your request, the credit reporting agency must send a notice of correction to any report recipient who has checked your file in the past six months.
For those items in your credit profile which you feel deserve further explanation (such as an account that was paid late due to sudden unemployment, military call-up, or unexpected medical bills), you may send a brief statement to the appropriate credit reporting agency. The information will be placed on your credit profile and will be disclosed each time your credit profile is accessed.
FICO Scores
FICO® scores were developed by Fair Isaac & Company, Inc. for each of the credit repositories. The scores are: (Equifax) Beacon®, (Experian formerly TRW) Experian/FICO and (TransUnion) Empirica®. They are simply repository scores meaning they only consider the information contained in a person's credit file; they do not consider a person's income, savings or down payment amount on a mortgage.
The scores were designed to assess risk. Scores are useful in directing applications to specific loan programs and to set levels of underwriting, i.e. streamline, traditional or second review. The scores are often objective, consistent, accurate and fast.
Many people in the mortgage business are skeptical about the accuracy of FICO scores. Scoring has only been an integral part of the mortgage process for the past few years; however, scores have been in use since the 1950's by retail merchants, credit card companies, insurance companies and consumer lending banks.
The scores are developed from each repository's database using actual loan performance information. A sample of over 750,000 consumers per repository was used. The repositories have each made great strides to increase the accuracy of their respective database through computer technology and internal monitoring. There is a new standard reporting format for credit grantors to use when sending electronic information to the repositories; this is the critical first step to providing accurate data.
The scores use a multiple scorecard design. Each repository uses 10 individual scorecards, and the models at each repository are the same. This increases accuracy and optimizes the predictive variables for each subpopulation. (For example, a borrower with two 30-day late payments will be scored against a population with some minor delinquencies.) This feature may cause a borrower with delinquencies to score in the same range as a borrower without delinquencies. Scorecards are reviewed and updated every twenty-four months.
The actual scoring process is proprietary, and the algorithms are copyrighted. We can share the predictive variables, the portion of the credit file considered and the weight as provided by Fair Isaac. They are:
Previous credit performance (35%)
Trade line information specific to payment history
Current level of indebtedness (30%)
Current balance compared to the high credit
Time credit has been in use (15%)
Opening date
Types of credit available
Installment loans, revolving accounts, debit accounts
Pursuit of new credit (less than 5%)
Inquiries
FICO has changed the way it factors credit checks and inquiries. These changes should minimize the "negative" effects that aggressive rate shopping or the normal mortgage process can have on a mortgage applicant. In the new Beacon version, the "deduping" process has been expanded beyond seven days. One variable counts the number of days within 365 days of scoring. If there has not been an inquiry, the "deduping" mechanism is not activated. If there is a consumer originated inquiry within the past 365 days from mortgage or auto related industries, these inquiries are ignored for the first 30 calendar days from scoring; then, multiple inquiries within the next 14 days are counted as one. Each inquiry will still appear on the credit report.
Scores should not change significantly because the variable in the model using inquiries contributes less than 5% of the predictive power of the model. According to Equifax statisticians, an average of 5% of the credit reports in the Equifax consumer credit reporting database (over 200 million consumer files) will see a change in score due to this. Fewer than 5% of those will see a change significant enough to affect a loan decision.
In order to get a score a borrower must have the following conditions in his/her file:
* No "Deceased" indicator on the credit file
* At least one undisputed trade line that has been updated in the last six months
* One trade line open at least six months
Scores range from 350 (high risk) to 950 (low risk). A scorecard of 660 will be 660 on Beacon 96, Empirica and Experian/FICO if the data on each file is the same. However, each repository is likely to contain different data.
Every score is accompanied by a maximum of four reason codes. Reason codes identify the most significant reasons a consumer did not score higher. They are not red flags. Consumers with scores in the 800 range get reason codes just as consumers with scores in the 500 range. The reason codes may be used in describing to the consumer the reason for adverse action. Scores are not part of the credit file and are not covered by the Fair Credit Reporting Act. Scores, if disclosed to the consumer, must be related to the credit file - using the reason codes - since the score has no meaning in itself; the meaning or risk level is assigned by the lender and the investor.
If erroneous information is reported it is important to document the inaccuracies right away and report it to the credit bureaus. The easiest way to do that is to have your credit-reporting agency upgrade the merged in-file to an edited mid-range report or to a Residential Mortgage Credit Report. With the upgraded report, you can ignore the score! The file will have to be handled in a traditional manner for underwriting and investment purposes. The developed report will provide the paper trail that investors want.
Credit Report Access
Businesses must have a "legitimate business need," and a "permissible purpose," to obtain your credit file. The Fair Credit Reporting Act (FCRA) outlines specifically who can see your credit profile. Otherwise, only you, and only those who you give written permission, can access your credit files. Your neighbors, friends, co-workers, and even your family members cannot have access to your credit profile unless you authorize it. Some examples of those who can access your credit files are:
* Credit grantors
* Collection agencies
* Insurance companies
* Employers
Any company that receives a copy of your credit profile will be listed under the "Inquiry" section of your report.
The Fair Credit Reporting Act (FCRA) is the federal law regulating credit reporting companies like Equifax, Experian, and TransUnion. It has been in effect since 1971. A revised FCRA became effective October 1, 1997. This law protects consumers' rights, such as the right to review and contest information in their credit profiles. It also specifically defines who can access the information in a credit profile, and how you are notified of this activity.
Credit Questions & Answers
Why do we need credit reporting?
Credit reporting provides information that helps consumers qualify for home loans, secure loans, student loans, and manage their personal finances. Credit reporting makes it possible for stores to accept your checks, banks to offer credit and debit cards, businesses to market products, and corporations to better manage their operations which benefit the world's economy.
What is a credit inquiry? An "inquiry" lists the name of a credit grantor, or authorized user who has accessed your credit file. Each inquiry is listed on your credit file so you know who has obtained a copy of it. Credit grantors post an inquiry before offering you a pre-approval credit card application. These are listed as "promotional" inquiries on your credit file because only your name and address were accessed, not your credit history information. They are NOT sent to credit grantors or businesses for reasons of credit reporting. They are listed for informational purposes only.
How does divorce affect consumer credit?
A divorce decree does not supersede the original contract with the creditor, and does not release you from legal responsibility on any accounts. You must contact each creditor individually and seek their legal binding release of your obligation. Only after that release can your credit history be updated accordingly.
Should I use one of those companies that promise to help correct my credit?
It's your choice. However, beware of companies promising to remove accurate information from your credit file. Accurate information cannot be removed from a credit file. There is nothing they can do for you that you cannot do for yourself by directly contacting the credit reporting agencies. Only time will heal a derogatory credit history.
A Credit Profile refers to a consumer credit file, which is made up of various consumer credit reporting agencies. It is a picture of how you (as an individual) paid back the companies you have borrowed money from, or how you have met other financial obligations.
There are usually five categories of information on a credit profile:
* Identifying Information
* Employment Information
* Credit Information
* Public Record Information
* Inquiries
What is NOT included on your on a credit profile:
* Your race
* Your religion
* Your health
* Your driving record
* Your criminal record
* Your political preference
* Your income |
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