Most people applying for a home mortgage loan need not worry about the effects of their credit history during the mortgage loan process. However, you can be better prepared if you get a copy of your Credit Report before you apply for your home mortgage. That way, you can take steps to correct any negatives before making your application.
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 paid back the companies you have borrowed money from, or how you have met other financial obligations. There are several categories of information on a credit profile:
- Identifying Information
- Employment Information
- Credit Information
- Public Record Information
Inquiries NOT included on your credit profile is race, religion, health, driving record, criminal record, political preference, or income. If you have had credit problems, be prepared to discuss them honestly with a mortgage professional who will assist you in writing your ‘Letter of Explanation.’ Knowledgeable mortgage professionals know there can be legitimate reasons for credit problems, such as unemployment, illness, or other financial difficulties.
If you had problems that have been corrected (reestablishment of credit), and your payments have been on time for a year or more, your credit may be considered satisfactory. The mortgage industry tends to create its own language, and credit rating is no different. BC mortgage lending gets its name from the grading of one’s credit based on such things as payment history, amount of debt payments, bankruptcies, equity position, credit scores, etc. Credit scoring is a statistical method of assessing the credit risk of a mortgage application. The score looks at the following items: past delinquencies, derogatory payment behavior, current debt levels, length of credit history, types of credit and number of inquires.
By now, most people have heard of credit scoring. The most common score (now the most common terminology for credit scoring) is called the FICO score. This score was developed by Fair, Isaac & Company, Inc. for the three main credit Bureaus; Equifax (Beacon), Experian (formerly TRW), and Empirica (TransUnion). FICO scores 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.
Credit scores are based on five factors: 35% of the score is based on payment history, 30% on the amount owed, 15% on how long you have had credit, 10% percent on new credit being sought, and 10% on the types of credit you have. The scores are useful in directing applications to specific loan programs and to set levels of underwriting such as Streamline, Traditional or Second Review. However, they are not the final word regarding the type of program you will qualify for or your interest rate.
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 (since 1999); however, the FICO scores have been used since the late 1950’s by retail merchants, credit card companies, insurance companies and banks for consumer lending. The data from large scoring projects, such as large mortgage portfolios, demonstrate their predictive quality and that the scores do work. The following items are some of the ways that you can improve your credit score:
- Pay your bills on time.
- Keep Balances low on credit cards.
- Limit your credit accounts to what you really need. Accounts that are no longer needed should be formally cancelled since zero balance accounts can still count against you.
- Check that your credit report information is accurate.
- Be conservative in applying for credit and make sure that your credit is only checked when necessary.
A borrower with a score of 680 and above is considered an A+ borrower. A loan with this score will be put through an ‘automated basic computerized underwriting’ system and be completed within minutes. Borrowers in this category qualify for the lowest interest rates and their loan can close in a couple of days. A score below 680 but above 620 may indicate underwriters will take a closer look in determining potential risk. Supplemental documentation may be required before final approval. Borrowers with this credit score may still obtain ‘A’ pricing, but the loan may take several days longer to close. Borrowers with credit scores below 620 are not normally locked into the best rate and terms offered. FHA may be a mortgage solution for in this score range but will be evaluated on a case-by-case basis. The loan terms and conditions are less attractive with these loan types and more time is needed to find the borrower the best rates.
All 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. Various combinations are allowed when determining your grade, but the worst-case scenario will push your grade to a lower credit grade. Late home mortgage payments and Bankruptcies/Foreclosures are the most important. Credit patterns, such as a high number of recent inquiries or more than a few outstanding loans, may signal a problem. Since an indication of a ‘willingness to pay’ is important, several late payments in the same time period is better than random lates.