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What Is A Credit Score?
When lenders evaluate your loan application,
they use a process called underwriting - they try to evaluate your ability and willingness
to repay your loan. They judge your ability to repay by looking at the
amount of your income and how stable your past earnings have been. This helps
them to determine if you can afford the loan payments. They judge your willingness
to repay by looking at your past credit history. Generally speaking, someone
who has made payments on time in the past will probably do so in the future.
Lenders want their evaluation to be
as accurate, objective and consistent as possible. In an effort to achieve
these goals, mortgage lenders recently began using credit scores to help in the underwriting
process. Credit scores are numerical values that rank individual's according
to their credit history at a given point in time. Your score is based on your
past payment history, the amount of credit you have outstanding, the amount of credit
you have available, and other factors. According to Fannie Mae and Freddie
Mac, two of the largest purchasers of home loans from lenders, credit scores have
proven to be very good predictors of whether a borrower will repay his or her loan.
Many lenders use credit scores to
help evaluate loan applications. However, a credit score is just one of many
factors considered in the underwriting process. Lenders look at the entire
picture. Even when a credit score is low, lenders try to find other factors
that could overcome the negative credit issues and satisfy their underwriting criteria.
The decision to approve or deny a loan may be made based on sound, flexible underwriting
guidelines.
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What Is A FICO Score?
"FICO" scores are a type
of credit score developed by a Fair Isaac & Company. FICO scores use credit
bureau information to obtain a score which indicates how likely someone is to make
their loan payments on time. Millions of consumers' credit bureau records were
used to develop the scorecards, and all of the consumer data - not just negative
information - was included to develop the system. FICO scores range
from approximately 350 to 900. The higher the score the more likely someone
is to make their payments. Similarly, the lower the score the more likely someone
is not to make their payments.
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How Can Credit Scores Affect The
Price Of A Loan?
Just as credit scores are one factor
in determining if you qualify for a loan, they may also be a factor in determining
the price of your loan. The price of a loan means the interest rate and the
points charged by the lender and/or a mortgage broker. The price charged for
a loan will be higher or lower depending on various factors.
Credit scores are used in determining
the price of a loan because they are believed to be good predictors of the borrowers
ability and willingness to repay a loan. Many mortgage loans are sold to investors,
and investors will pay a more favorable price for loans they feel have a low risk
of default. Fannie Mae and Freddie Mac use credit scores as their analysis
when pricing loans they buy from lenders because of this very reason. Thus,
applicants with lower credit scores may pay higher prices for their loans because
of the higher risk of default and loss.
There are many other factors relating
to an individual borrowers situation that may also affect the price of a loan, often
even more so than credit scores. These include: the type of property securing
the loan (detached single family residence, duplex, etc.); the amount of the borrower's
equity in the property; the lenders costs to make the loan; and the type of loan
selected. For example, a loan secured by a single family residence may have
a lower price than a loan secured by a duplex because duplexes are more difficult
to sell than single family residences. Similarly, the price of a loan where
the borrower has made a 20% down payment may be less than a loan where the borrower
has made a 5% down payment because the first borrower has more equity in the property
and, thus, the greater incentive to make the payments on the loan.
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How To Improve Your Credit Score:
Because each borrower's credit score
is a reflection of his or her unique credit profile, it is not possible to quantify
in advance exactly how each item in your credit history numerically impacts upon
your ultimate credit score. No one can tell you, for example, how much your
credit score will be affected if you pay off a
delinquent account or cancel a credit card. We do know, however, that there
are things you can do to improve your credit profile. Some of the factors which
may impact your credit scores include:
- Making timely
payments: Making your payments on time is the best way
to increase your score. Delinquency, foreclosures, bankruptcies and judgments
will decrease your score.
- Limit the number
of trade lines: The number of credit cards, lines of credit
and other types of credit (" trade lines ") you have available will affect
your score. If you have a lot of trade lines, this may decrease your score
because of the risk that you might not be able to pay off all of your accounts, and
this may affect your ability to pay off your mortgage loan. You may wish to
consider canceling credit cards you do not use regularly or choosing 2 to 4 cards
to use and canceling the rest. If you close or cancel an account voluntarily,
it will not have a negative effect on your credit score. You may wish to reconsider
accepting "pre-approved" offers for your credit cards, or if you accept
an offer, perhaps you should cancel another credit card. On the other hand,
if you have no trade lines, this will likely decrease your score. Lenders generally
want to see that you have some available credit and that you can handle your credit
wisely.
- Avoid unnecessarily
high credit limits: Lenders
also consider the amount of credit available to you (your credit limit) compared
to your income when making underwriting decisions. Having credit limits that
are too high relative to your income can affect your score just like having too many
trade lines.
- How you use credit: The amount outstanding on each of your credit cards will also affect
your score. In general, the lower the amount outstanding, the more likely it
is that your score will be higher.
- Do not apply
for credit you do not need: Whenever you apply for credit, the creditor
will obtain a credit report from one or more of the three credit bureaus. Each
such credit inquiry will stay on your record and will affect your credit score.
Even if you are turned down for credit or change your mind and withdraw your application,
your credit score will be affected. This is because each inquiry suggests that
you are increasing the amount of credit available to you. Before you give your
Social Security number to anyone, make certain you know how they are going to use
it. A Social Security number is almost always required to run a credit report.
But don't let the fear of inquiries stop you from shopping for the best deal when
you need auto or home financing. Recently, the credit bureaus have recognized
that borrowers may apply for credit at more than one place for the same transaction.
Generally, the credit scoring companies will consider all auto or mortgage loan inquiries
received it in a 14 day period as one inquiry so the additional inquiries will not
affect your credit score. And remember, if you order a copy of your credit
report to make sure it is accurate, this will not show up as an inquiry on your record.
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How To Correct Mistakes On Your
Credit Report:
Because credit scores are based upon
your credit record, it is very important that you obtained a copy of your credit
report from time to time to make certain the information is accurate. If the
information is not accurate (for example, someone else with the same name as yours
may have their credit mixed up with yours), you should immediately take steps to
get it corrected. No one can do this but you.
Lenders, credit card issuers and other
credit providers send regular reports about their accounts to the major credit bureaus.
This is where the information on your credit report comes from. There are three
major credit bureaus; you should contact each one because not all credit providers
report to each bureau. Also, if you have a joint credit (for example, if you
are married and have joint accounts with your spouse), it is a good idea to get the
credit report for each of you because there may be information on one report that
does not appear on the other. If you ask for a copy of your credit report to
check your credit history, it will not affect your credit score. You can
reach the 3 credit bureaus at the following phone numbers:
| Equifax: |
|
800-685-1111 |
| TransUnion: |
|
610-690-4949 |
| Experian (TRW): |
|
800-682-7654 |
In most cases, there is a small charge
to obtain a copy of your credit report. If you find errors on your credit report,
follow the directions included with your credit report regarding disputes or errors.
Generally, you must write the credit bureau and advise them of the error or dispute.
You may need to provide proof that the bill was paid or other information about the
claim or dispute. The credit bureau will then contact the provider of credit
who reported the information, and the provider will have 30 days to respond.
If the provider of credit agrees that there is an error, it will instruct the credit
bureau to delete the item from your credit report.
You should allow at least 30 days
after you have notified a credit bureau of an error in your credit report for that
error to be investigated and resolved. It may take longer depending upon the
nature of the error and the investigation to be done.
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