When you apply for a mortgage loan, you expect your lender to pull a credit report and look at whether you've made your payments on time. What you may not expect is that they seem to be more interested in your "FICO" score.
What's a FICO score?" is a common reaction.
Each time your credit report is pulled, it is run through a computer program with a built-in scorecard. Points are awarded or deducted based on certain items such as how long you have had credit cards, whether you make your payments on time, if your credit balances are near maximum, and assorted other variables. When the credit report prints in your lender's office, the total score is displayed. Your score can be anywhere between the high 300's and the low 800's.
Lenders wanted to determine if there was any relationship between these credit scores and whether borrowers made their payments on time, so they did a study. The study showed that borrowers with scores above 680 almost always made their payments on time. Borrowers with scores below 600 seemed fairly certain to develop problems.
As a result, credit scoring became a more important factor in approving mortgage loans. Credit scores also made it easier to develop artificial intelligence computer programs that could make a "yes" decision for loans that should obviously be approved. Nowadays, a computer and not a person may have actually approved your mortgage.
In short, lower credit scores require a more thorough review than higher scores. Often, mortgage lenders will not even consider a score below 600.
The likelihood of a ninety day delinquency for specific FICO scores.
Odds of a Delinquent Account
2 to 1
4 to 1
9 to 1
18 to 1
36 to 1
72 to 1
144 to 1
576 to 1
Some of the things that affect your FICO score are:
- Too many accounts opened within the last twelve months
- Short credit history
Balances on revolving credit are near the maximum limits
- Public records, such as tax liens, judgments, or bankruptcies
- No recent credit card balances
- Too many recent credit inquiries
- Too few revolving accounts
- Too many revolving accounts
What is FICO?
FICO stands for Fair Isaac & Company and is the name for the most well known credit scoring system, used by the Experian (formerly TRW) credit bureau to calculate credit scores. Trans-Union and Equifax are two other credit bureaus who also provide credit scores.
The credit bureau's computer evaluates a complete credit profile and assigns a score, which is used to estimate credit worthiness. Each of the three bureaus (Experian, Trans Union, Equifax) employs its own scoring system, so a given person will usually have 3 separate scores. Someone with a higher score will be viewed as a better risk than someone with a lower score. Typically, scores will range from about 600 to 700 or above, although some cases will be outside this range.
What Kind of Score Do I Need for a Home Loan?
There are as many answers to this question as there are loan programs available. Most lenders will take the average of all 3 scores to evaluate an application. "Niche" loans, such as Easy Qualifier and low down payment loans will have the higher FICO requirements.
How is My Score Determined?
The FICO model has 5 main elements:
- Past payment history (about 35% of score) The fewer the late payments the better. Recent late payments will have a much greater impact than a very old Bankruptcy with perfect credit since.
- Credit use (about 30% of score) Low balances across several cards is better than the same balance concentrated on a few cards used closer to maximums. Too many cards can bring down the score, but closing accounts can often do more harm than good if the entire profile is not considered. BE CAREFUL WHEN CLOSING ACCOUNTS!
- Length of credit history (15% of score) The longer accounts have been open the better for the score. Opening new accounts and closing seasoned accounts can bring down a score a great deal.
- Types of credit used (10% of score) Finance company accounts score lower than bank or department store accounts.
- Inquiries (10% of score) Multiple inquiries can be a risk if several cards are applied for or other accounts are close to maxed out. Multiple mortgage or car inquiries within a 14 day period are counted as one inquiry.
Paying off cards with recent late payments will fix things.
Payoffs do not affect payment history.
How Can I Raise My Score
Your score can only be changed by the way that item is reported directly to the credit bureaus (Experian, TU, Equifax). Written confirmation from the creditor is required. It is best to make these corrections before you try to purchase a home, because you can never be sure the exact impact a change will have on your score.
You should have your credit reviewed BEFORE you look for a home, and work with a PROFESSIONAL loan officer to make sure your loan is based on the most accurate information.
FICO Scores and Interest Rates
Credit scores can affect more than whether your loan gets approved or not. They can also affect how much you pay for your loan, too. Some lenders establish a "base price" and will reduce the points on a loan if the credit score is above a certain level. For example, one major national lender reduces the cost of a loan by a quarter point if the FICO score is greater than 725. If it is between 700 and 724, they will reduce the cost by one-eighth of a point. A point is equal to one percent of the loan amount.
There are other lenders who do it in reverse. They establish their base price, but instead of reducing the cost for good FICO scores, they "add on" costs for lower FICO scores. The results from either method would work out to be approximately the same interest rate. It is just that the second way "looks" better when you are quoting interest rates on a rate sheet or in an advertisement.
FICO Scores and Mortgage Underwriting Decisions
FICO Scores as Guidelines
FICO scores are only "guidelines" and factors other than FICO scores affect underwriting decisions. Some examples of compensating factors that will make an underwriter more lenient toward lower FICO scores can be a larger down payment, low debt-to-income ratios, an excellent history of saving money, and others. There also may be a reasonable explanation for items on the credit history which negatively impact your credit score.
They Don't Always Make Sense
Even so, sometimes credit scores do not seem to make any sense at all. One borrower with a completely flawless credit history had a FICO score below 600. One borrower with a foreclosure on her credit report had a FICO above 780.
Portfolio & Sub-Prime Lenders
Finally, there are a few "portfolio" lenders who do not even look at credit scoring, at least on their portfolio loans. A portfolio lender is usually a savings & loan institution who originates some adjustable rate mortgages that they intend to keep in their own portfolio instead of selling them in the secondary mortgage market. They may look at home loans differently. Some concentrate on the value of the home. Some may concentrate more on the savings history of the borrower. There are also "sub-prime" lenders, or "B & C paper" lenders, who will provide a home loan, but at a higher interest rate and cost.
Running Credit Reports
One thing to remember when you are shopping for a home loan is that you should not let numerous mortgage lenders run credit reports on you. Wait until you have a reasonable expectation that they are the lender you are going to use to obtain your home loan. Not only will you have to explain any credit inquiries in the last ninety days, but numerous inquiries will lower your FICO score by a small amount. This may not matter if your FICO is 780, but it would matter to you if it is 642.
Don't Buy A Car Just Before Looking for a Home!
In conclusion, a word of advice not directly related to FICO scores. When people begin to think about the possibility of buying a home, they often think about buying other big ticket items, such as cars. Quite often when someone asks a lender to pre-qualify them for a home loan there is a brand new car payment on the credit report. Often, they would have qualified in their anticipated price range except that the new car payment has raised their debt-to-income ratio, lowering their maximum purchase price. Sometimes they have bought the car so recently that the new loan doesn't even show up on the credit report yet, but with six to eight credit inquiries from car dealers and automobile finance companies it is kind of obvious. Almost every time you sit down in a car dealership, it generates two inquiries into your credit.
Protect Your FICO Score
Credit History is Important. Nowadays, credit scores are important if you want to get the best interest rate available. Protect your FICO score. Do not open new revolving accounts needlessly. Do not fill out credit applications needlessly. Do not keep your credit cards nearly maxed out. Make sure you do use your credit occasionally. Always make sure every creditor has their payment in their office no later than 29 days past due.
And never ever be more than thirty days late on your mortgage. Ever.