What is a credit score and how does it affect you?
Before deciding on what terms they will offer you a loan (which they base on their "risk"), lenders want to know two things about you: your ability to pay back the loan, and your willingness to pay back the loan. For the first, they look at your income-to-debt obligation ratio. For your willingness to pay back the loan, they consult your credit score.
The most widely used credit scores are FICO scores, which were developed by Fair Isaac & Company, Inc. (and they're named after their inventor!). Your FICO score is between 350 (high risk) and 850 (low risk).
New Fannie Mae guidelines further dictate that your overall interest rate can be severely impacted by lower scores as of January 1, 2008. Borrowers with scores below 680 will now be faces with higher rates, or a penalty fee in the form of points to avoid the increase in rates. The penalties are assessed in 4 tiers with the highest point assessment being 2% of the loan amount for scores between 620 and 640. Scores between 640 and 660 will see an assessment of 1.5 % while scores between 660 and 680 will have to pay .75% to obtain interest rates available to those with scores higher than 680 with no added fees. Here are some examples to illustrate the payment savings based on a $100,000 loan:
Interest Rate 5.625% 5.875% 6.000% 6.375% 6.500% Term 30 Yr. 30 Yr. 30 Yr. 30 Yr. 30 Yr. Rate Type Fixed Fixed Fixed Fixed Fixed MONTHLY PAYMENT SUMMARY 30 Year Fixed - score above 680 Score between 660 - 680 Score between 640 - 660 Score between 620 - 640 Score less than 620
Total Monthly Payment $815.66 $831.54 $847.61 $863.87 $872.07 PAYMENT SAVINGS ($15.88) ($31.95) ($48.21) ($56.41) TOTAL PAYMENT COST ENDING YR. 7 ($1,333.92) ($2,683.80) ($4,049.64) ($4,738.44) Credit scores only consider the information contained in your credit profile. They do not consider your income, savings, down payment amount, or demographic factors like gender, race, nationality or marital status. In fact, the fact they don't consider demographic factors is why they were invented in the first place. "Profiling" was as dirty a word when FICO scores were invented as it is now. Credit scoring was developed as a way to consider only what was relevant to somebody's willingness to repay a loan.
Past delinquencies, derogatory payment behavior, current debt level, length of credit history, types of credit and number of inquiries are all considered in credit scores. Your score considers both positive and negative information in your credit report. Late payments will lower your score, but establishing or reestablishing a good track record of making payments on time will raise your score.
Different portions of your credit history are given different weights. Thirty-five percent of your FICO score is based on your specific payment history. Thirty percent is your current level of indebtedness. Fifteen percent each is the time your open credit has been in use (ten year old accounts are good, six month old ones aren't as good) and types of credit available to you (installment loans such as student loans, car loans, etc. versus revolving and debit accounts like credit cards). Finally, five percent is pursuit of new credit -- credit scores requested, or inquiries.
Your credit report must contain at least one account which has been open for six months or more, and at least one account that has been updated in the past six months for you to get a credit score. This ensures that there is enough information in your report to generate an accurate score. If you do not meet the minimum criteria for getting a score, you may need to establish a credit history prior to applying for a mortgage.
What can you do about your FICO score? Since the score is based on a lifetime of credit history, it is difficult to make a significant change in the number with quick fixes. The most important thing is to know your FICO score and to ensure that your credit history is correct. Conveniently, Fair Isaac has created a web site (www.myFICO.com) that let's you do just that. For a reasonable fee, you can quickly get your FICO score from all three reporting agencies, along with your credit report. Also available is some helpful information and tools that help you analyze what actions might have the greatest impact on your FICO score. Each of the credit services offers similar services on their web sites: www.equifax.com, www.experian.com, and www.transunion.com.
A word about Consumer Credit Counseling Services: Nonprofit debt counseling services assist people who are over their heads in debt and are seeking an alternative to bankruptcy. CCCS are funded and controlled by credit grantors and credit bureaus. When you are working with CCCS your creditors will often note this on your credit report. This is a huge red flag for prospective credit grantors - treated the same as Chapter 13 bankruptcy. Some of the very worst credit reports that we see are or have been participants in the CCCS or similar programs
For a personal consultation of our credit score and your ability to qualify for a mortgage loan, please don't hesitate to phone me anytime. I'm happy to go through your report with you and help you analyze each account. There is never any obligation for this service.
Armed with this information, you will be a more informed consumer and better positioned to obtain the most favorable mortgage available to you.