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CREDIT SCORING . . . HERE TO STAY!

The Fair, Isaac Credit Bureau Scores, known as FICO Scoring, was introduced to mortgage lending nearly three decades ago. The past credit history of a borrower is examined to determine the likelihood of timely future payments on a new mortgage.

We’ve always known that a few late payments did not make a borrower a high credit risk. On the contrary, the trick has been to develop a method by which we could identify a borrower’s likelihood of paying their mortgage on time. This scoring not only assesses how likely a borrower is to pay back a loan, but also measures the degree of risk a borrower represents to the lender. Scores range from 300 to 900 (depending upon the repository reporting), the higher score indicating better credit quality.

In measuring the relationship between credit scores and default records, lenders have learned that there are many more dimensions to credit than just reviewing and explaining a late payment record.

There are 33 “variables”, grouped into five categories, gathered for a borrower’s credit profile. Some of the items include: 1. Previous Credit Performance: Examining late payments, judgments, collections, etc. and how recently they occurred. 2. Current Level of Debt: Number of outstanding account balances vs the credit limit. 3. Pursuit of New Credit: Review of the number of inquiries made by creditors & new accounts opened during the past year. 4. The Time Credit Has Been Used: Examination of how old the accounts are. 5. Types of Credit in Use: Are the accounts bank, gas, entertainment, department store credit cards, personal loans, auto or installment loans? Installment debt and low balances on bankcards result in the higher scores In other words, we no longer merely look at “good” vs “bad” credit as a means to determine the likelihood of making future mortgage payments.

Most Recent indications of the “weight” given to scoring goes like this:

  1. Late Payment History: 35%
  2. Current Level of Debt: 30%
  3. Pursuit of New Credit: 10%
  4. Length of Credit: 15%
  5. Type of Credit: 10%

Here is one way in which you might “interpret” the above information:

  1. Pay on time, all the time
  2. Don’t exceed 30% of any revolving credit line.
  3. Keep some revolving accounts open.  Most lenders look for a minimum of 3 credit lines available, especially if you must seek some form of niche loan. Today’s practice of constantly transferring account balances to lower interest rate bearing cards, while a good business decision, could result in lowering a score.
  4. Avoid finance company credit. Use banks and credit cards.
  5. Don’t apply for credit unless you need it.  Inquiries during the past twelve months are reviewed and can impact a score.  Two exceptions . . . mortgage and auto inquiries within a 30 day period of each other count as one inquiry.

Should a consumer be denied a loan due to a low score, clues as to why might be found by reviewing the four “most significant reasons” for the low score as provided by the credit provider. These are generally the four most important factors that affected the score and kept it from being higher.

In spite of wide spread skepticism regarding the impact that this process might have on acquiring loan approvals, lending sources indicated that this scoring system has proven to be an objective and reliable method of qualifying potential home buyers. Controversy continues, however, around the issues of the type of credit information used to develop the scores and how to change erroneous information contained in a borrower’s credit file.

The credit scoring process may benefit borrowers via the current “automated underwriting” programs wherein speedier approvals can now be made. Some say that the automated systems allow greater flexibility in qualifying borrowers than was previously allowed under more traditional underwriting processes.

While scores above 680, up until recently, required minimum credit review and were often approved with minimum “conditions”, this has changed. 740 has become the current basic score and anything less generally requires a more comprehensive review of the borrower’s credit and ability to meet loan standards. Scores below 620 are now generally not acceptable except for government approved loan options (FHA, VA, Guaranteed Rural Housing).  On the conventional side, a score below 700 will likely require a more “cautious” review and could result in the borrower having to accept a less desirable rate and terms and, in some cases, being denied their loan request. While borrowers with scores as low as 620 can acquire a loan, the “risk based” underwriting guidelines will require a higher rate and sometimes fees.

A few arbitrary minimum scores have been identified for certain types of financing. For instance, many non-owner occupied purchase options with an LTV exceeding 70% often requires a minimum 720 credit score to avoid increases to rate and/or fees. On the other hand, while FHA, VA and Guaranteed Rural Housing guidelines continue to indicate that they “look at” the scores but do not determine the borrower’s approval predicated on scores alone now requires a minimum 620 score (some lenders indicate that they will accept scores as low as 580 for government type loans but these lare not prevlent). The confusion is that while the agencies do adhere to the “scores are only reviewed” concept, lenders who fund the loans require the 620 minimum score.

Lower scoring borrowers had in the past an option in seeking “niche” loan products when their credit scores were insufficient to qualify for the more competitive loan options. The result often was a higher interest rate and terms via the sub-prime loan market. Those options are closed for now.  But, the system is under constant review to determine the revisions necessary to determine the credit worthiness of the lower scoring applicant. In other words, they recognize that all low scoring applicants are not necessarily bad risks for home loans. Via refinement, the system continues to try to better identify those “good” borrowers, in spite of what might be considered a low score. We anticipate and welcome more information soon.

Each of the three credit repositories have web sites at which borrowers can obtain credit information.  When applying for a home loan, the lender requires a report from all three repositories. Humboldt Home loans will obtain a credit report during your loan process. While a would-be borrower may acquire a separate report from each repository the acquisition of a free report might provide an indication of the credit score.

But you may find it useful to “get an idea” regarding what your credit looks like by accessing one of the repositories? The equifax site is recommended as the most user friendly by many, but here are all three sites.
 www.econsumer.equifax.com
  www.transunion.com
www.experian.com

While Fair Isaac continues to “suggest” that consumers will not understand their report, the above sites at least now exist. The sites can confuse the issue a bit by providing scores that differ from the typical mortgage three merged report. The good news is that they do attempt to provide information regarding how to interpret the scores.  Consumers can also contact Fair Isaac at their website of www.fairissac.com for general credit score information.  For the consumer interested in “behind the scenes information” www.myfico.com may be interesting as it attempts to explain various aspects of credit reports and credit scoring.

While constantly evolving, the automated underwriting system, given today’s more inflexible approval process, revolutionized the lending industry. Its flexibility and quickness in approving loans likely far outweighs any current negatives with the program. Thus, credit scoring is here to stay. It makes sense that prospective borrowers become pre-approved for a loan, which will include the examination of the borrower’s FICO scores to assure their ability to acquire their desired loan.

THE FOLLOWING IS GOOD ADVICE IN TODAY’S WORLD OF CREDIT SCORING!

  1. Close “inactive” credit card accounts.
  2.  Always be cautious of giving your Social Security Number and other personal information to prevent premature credit “inquiries”. (Such as when ‘shopping’ for a car, or other large purchases.)
  3. Reduce the number of credit cards held to a minimum. It may no longer be prudent to retain too many credit cards (with too much “available” credit). Retain only those cards typically used.  On the other hand, it may be a good idea to maintain a minimum number of “credit lines” available. Many lenders require a minimum of three to four credit lines available if a borrower is to be considered for financing.
  4. If an unsolicited credit card is mailed to you (that you did not apply for, nor want to use), do not reply in any way.  Destroy the card and do not use it, not even one time. Our understanding is that no “inquiry” is noted on your credit report as a result of these unsolicited mailings.