Why is Your Credit Score so Important?
The credit scoring model seeks to quantify
the likelihood of a consumer to pay of debt without being more than
90 days late at any time in the future. Credit scores can range
from a low of 300 and a high of 900. Most consumers have credit
scores that range between 400 and 800. The higher the score, the
better it is for the consumer. A higher score can translate into
and lower interest rate and save the consumer money.
Only one out of 1,300 people in the
United States have a credit score above 800. These are people
with stellar credit rating that get the best interest rates. On
the other hand, one out of every eight prospective home buyers is faced
with possibility that they may not qualify for the home loan they want
because they have a score falling between 500 and 600.
The 5 factors
of credit scoring
Credit scores are comprised of five
factors. Points are awarded for each component, and a high score
is most favorable. The factors are listed below in order of importance.
- Payment History- 35%
Impact
Paying debt on time and in
full has the greatest positive impact on your credit score. Late
payments, judgments and charge-offs all have a negative impact.
Missing a high payment will have a more severe impact than missing a
low payment, and delinquencies that have occurred in the last two years
carry more weight than older items.
- Outstanding credit balances-
30% Impact
This factor marks the ration
between the outstanding balance and available credit. Ideally,
the consumer should make an effort to deep balances as close to zero
as possible, and at least 10% below the available credit limits.
(A balance 30% below the available credit limit is better.)
- Credit History- 15% Impact
This portion of the credit
score indicates the length of time since a particular credit line was
established. A seasoned borrower will always be stronger in this
area.
- Type of Credit- 10% Impact
A mix of auto loans, credit
cards and mortgages is more positive than a concentration of debt from
credit cards only.
- Inquiries- 10% Impact
This percentage of the credit
score quantifies the number of inquiries made on a consumer’s credit
within a six-month period. Each hard inquiry can cost from two
to 25 points on a credit score, but the maximum number of inquiries
that will reduce the score is ten. In other words, 11 or more
inquiries within a six-month period will have no further impact on the
borrower’s credit score. Note that if you run a credit report
on yourself, it will have no affect on your score.
Remember that the credit score is a
computerized calculation. Personal factors are not taken into
consideration when a credit report is generated. It is merely
a snapshot of today’s credit profile for any given borrower, and it
can fluctuate dramatically within the course of a week.
How does a low
credit score affect my interest rate?
Lenders estimate your ability to pay
back money based on your credit score. The risk factor they take
on is built-in to your interest rate as a financing fee. Therefore,
a low credit score results in a higher interest rate, higher monthly
fees, and a higher amount of interest being paid over the total life
of the loan.
The following chart illustrates the
difference in the amount of interest paid over the life of the same
loan with three different credit score scenarios.
30-Year Fixed Rate with Principal
Loan Amount of $250,000
| FICO Score |
APR | Monthly Payment | Interest Paid |
| Above 720 | 5.71% | $1,453 | $272,928 |
| 620 to 719 | 5.796% to 7.84% | $1,446 to $1,807 | $277,845 to $400,381 |
| Below 620 | 8.452% to 9.234% | $1,914 to $2,054 | $438,957 to $489,365 |
A borrower in increases his or her
credit score from 620 to 720+ can potentially save $601 per month on
mortgage payments, $7,214 per year, and approximately $216,432 over
the life of the 30-year loan.*
*Source: Credit Resource Corp.,
How Much does a Low Score Cost You?
How does the underwriter
view my score?
If you are considering a home purchase,
it is in your best interest to make every effort to increase your credit
score; especially if you know you have issues you should dealing with.
It is often the case that people are not aware of bad marks on their
credit record until they apply for financing for a major purchase, such
as a home.
As part of the loan process, we run
a credit report for you. But you can take advantage of the opportunity
to get a free credit report from each of the crediting reporting agencies
(CRA): Equifax, Experian and TransUnion. As a sidebar, you can
choose to get the free report from all three bureaus at the same time,
so you are aware of what information each bureau has collected.
Another option is to pull your credit report from one agency, and reserve
the right to get your free reports from the other two CRAs as you work
to improve your credit standing.
We believe it is best to have the full
overview up front. Different CRAs have different methods of calculating
these scores, and may also have different information contained within
their findings. Consider the adage, “Why jump over nickels to
pick up pennies?” If additional reports are needed within a
12-month period from any of the three CRAs, the cost is extremely minimal
compared to the potential savings that can be realized by an improved
credit score, and if you run a credit report on yourself it will not
affect your own score as an inquiry.
The underwriter who is making the decision
as to whether or not you should get the loan you are asking for will
generally look at the scores generated from all three CRAs. Typically,
the score will not be the same from all three reports, and the underwriter
will consider the middle score as a barometer.
Disputing errors
on the credit report
If you are in the process of reviewing
our credit reports, the first thing to do is make sure that the information
contained within the reports is correct. In June 2004, The U.S.
Public Interest Research Group published the results of a survey it
conducted involving 200 adults in 30 states to test the validity of
credit reporting. Their findings were as follows:
- Twenty-five percent (25%)
of the credit reports contained errors serious enough to result in the
denial of credit. - Seventy-nine percent (79%)
of the credit reports contained mistakes of some kind. - Fifty-four percent (54%)
of the credits reports contained personal demographic information that
was misspelled, long-outdated, belonged to a stranger, or was otherwise
incorrect. - Thirty percent (30%) of
the credits report contained credit accounts that had been closed by
the consumer but incorrectly remained listed as open.
Source: U.S. Public Interest Group
Research; One in Four Credit Reports Contains Errors Serious Enough
to Wreak Havoc For Consumers, US PIRG Press release, 6/17/04
If you find that you have errors on
your credit report, follow this procedure to correct those errors.
- Make a copy of the report
and circle the items you are questioning. Keep your
original copy for your own records. - Prepare a letter to the
CRA that provided you with the report in question, and request to have
the erroneous item(s) removed. If you have proof of payment for
an item in question, include a copy of that documentation. - Prepare a letter to the
creditor reporting the problem, especially if you feel you are a victim
of fraud or identity theft. Inform the creditor that you are disputing
an error reported to the CRA, state why the claim is inaccurate, and
include any relevant documentation to prove your point. - Send your correspondence
via certified mail.
You should receive a response from
the CRA within 30 to 45 days. If the error has been corrected,
they will send you a fresh copy of your credit report at no charge to
show you that the item has been removed. They will also send a
corrected report to any entity that received a report that contained
errors within the last six months.
If you cannot have a disputed item
removed, you have the right to include your side of the story on the
credit report. Your statement should be a concise explanation
(100 words or less) as to why you are challenging the item in question.
From that point on, this notation will be included in your credit report
as long as the item in question remains on your report.
What if I have
no credit?
On occasion, a borrower will not have
enough credit references to obtain the loan they wish to secure.
If this is the case for you, start by opening small lines of credit
that report to one of the three major CRAs, and make purchases that
can be paid off easily. If you do not already have a checking
or savings account, open one. Your bank or credit union may be
able to provide you with a credit card account once you have established
a history with them as a customer.
Ask your family or spouse to add you
to their credit card account. By adding your name to an established
line of credit, you can ride on their coattails, so to speak, and gain
points by using that person’s credit history.
It is also wise to start saving money
for the down payment on your home. The lender will look at your
application more favorably when you are able to come to the table with
a 20% down payment. Bear in mind, there are certain loan programs
available that permit a percentage of gift money for down payment, which
can come from a relative, or even the person selling the home.
Dealing with credit
challenges
Unfortunately, a person with a bad
credit score is often in this position because he or she lacks the discipline
to pay bills on time. Of course, there are exceptions where unforeseen
circumstances come into play, such as health complications, or loss
of employment.
There are a few things that may be
able to bring your score up so that you can secure a better interest
rate on your mortgage loan.
Example 1: Distribute debt from
revolving credit.
Our borrower, Mr. Jones, has a credit
score of 664. He has five credit cards, but his Visa account is
almost maxed out. His other four credit cards have relatively
low balances. Mr. Jones moves part of the debt from the Visa account
to the other major credit major credit card accounts, thus distributing
the debt more evenly over the five cards. This changes the ratio
of debt to available credit (which has a 30% impact on the overall credit
score), and Mr. Jones successfully raises his credit score by 20 points
with very little effort.
Example 2: Transfer outstanding
balances to new accounts.
Our borrower, Ms. Smith, has only two
credit cards, but both are pushing the limit of available credit.
Ms. Smith opens two new credit card accounts, each with a credit limit
of $5000. She transfers part of her existing balances to the new
accounts. While she has acquired two new cards that have no established
history, the greater impact is the change in the ration of debt to available
credit.
Ultimately, experts say that it is
best to have two to five credit cards, and no more than that.
You should keep your balances as low as possible. If you have
a credit account with a zero balance, do not close the account.
Instead, make a small purchase so the card shows up as an active account
on your credit report, and you will be awarded points for your long-term
credit history.
Do’s and don’ts
during the loan process
When you fill out a credit application,
we run a credit report for the underwriter. Each lender and each
loan program has different guidelines they must follow. You should
not do anything that will have an adverse affect on your credit score
while your loan is in the process. We know it’s tempting…
If you’re moving into a new home, you might be thinking about purchasing
new appliances or furniture, but this is really not the right time to
go shopping with your credit cards. You’ll want to remain in
a stable position until the loan closes to ensure that you can lock
into the best interest.
Here is a handy list of do’s and
don’ts that you should adhere to after your loan application has been
submitted to the lender.*
Don’t apply for new credit of any kind- If
you receive invitations to apply for new lines of credit, don’t respond.
If you do, that company will pull your credit report and this will have
an adverse effect on your credit score. Likewise, don’t establish
new lines of credit for furniture, appliances, computers, etc.
Don’t pay off collections or charges-offs- Once
your loan application has been submitted don’t pay off collections
unless the lender specifically asks you to in order to secure the loan.
Generally, paying off old collections causes a drop in the credit score.
The lender is only looking at the last two years of activity.
Don’t close credit card accounts- If you close
a credit card account, it can affect your ratio of debt to available
credit which has a 30% impact on your credit score. If you really
want to close an account, do it after you close your mortgage loan.
Don’t max out or over charge existing credit cards-
Running up your credit cards is the fastest way to bring your score
down, and it could drop up to 100 points overnight. Once you are
engaged in the loan process, try to keep your credit cards below 30%
of the available credit limit.
Don’t consolidate debt to one or two cards-
Once again; we don’t want you to change your ratio to debt to available
credit. Likewise, you want to keep beneficial credit history on
the books.
Don’t raise red flags to the underwriter-
Don’t co-sign on another person’s loan, or change your name and
address. The less activity that occurs while your loan is in process,
the better it is for you.
Do join a credit watch program- Your bank,
credit union or credit card company may be able to provide you with
a free credit watch program that can alert you to any changes in your
credit report. This can be a safeguard to help you intervene before
the underwriter sees a problem.
Do stay current on existing accounts- Late
payments on your existing mortgage, car payment, or anything else that
can be reported to a CRA can cost you dearly. One 30-day late
payment can cost anywhere from 30 to 75 points on your credit score.
Do continue to use your credit as you normally
would- Red flags are easily raised within scoring system.
If it appears you are diverting from your normal spending patterns,
it could cause your score to go down. For example, if you’ve
had a monthly service for Internet access billed to the same credit
card for the past three years, there’s really no reason to drop it
now. Again, make your changes after the loan funds.
Do call your loan consultant- If you receive
notification from a collection agency or creditor that could potentially
have an adverse affect on your credit score, call us so we can try to
direct you to the right resources and prevent any derogatory reporting
to credit bureaus.
*Source: Based on The Top 10 Credit
Do’s and Don’ts During the Loan Process,
provided by Credit Resource Corp.
Credit remediation
If you feel you would prefer to work
with a credit repair service rather than try to tackle credit repair
issues on your own, please give us a call so we can help you sort through
your options. We will do our best to refer you to a reputable
credit remediation service and guide you in the right direction once
we have the opportunity to review your credit report with you.
The Federal Trade Commission (FTC)
regulates credit repair services and provides free information to help
consumers spot, stop and avoid doing business with credit repair companies
that are not reputable. Their web site is located at http://www.ftc.gov
You can also write to the FTC to request
a copy of their free brochure titled Credit Repair: Self Help May
Be Best, which includes information about credit clinics.
The address to write is:
Federal
Trade Commission
Sixth
and Pennsylvania Avenues, NW
Washington,
DC 20004
If you have any complaints regarding
your credit report or credit remediation services that you wish to report
to the FTC, contact them at:
Federal
Trade Commission
Consumer
Response Center, Room 130
600
Pennsylvania Avenue, NW
Washington,
DC 20580
