Credit Never Sleeps
Everyday we deal with credit – especially in the mortgage business.
One of the biggest determining factors in getting a home mortgage are your credit scores.
So why are they so important?
Credit is derived from algorithms developed by Credit Bureaus to determine your credit worthiness.
Think about long ago before there were credit bureaus and rating agencies.
The farmer would walk into his local feed store to buy feed and supplies for the season. That store would have kept tabs on –
- Did they pay on time?
- Did they pay at all?
- How long did it take them to pay?
- How long have they been a customer?
- How much credit have we given this customer versus how much have they used?
- How much credit can this farmer actually afford based on his crop sales in years’ past?
As business and banks evolved, they wanted to have a more formal way of keeping track of customers and their credit worthiness (I’ll spare you a history lesson on Credit – you have Google!)
Fast forward 100+ years – now businesses, banks, bonds, and personal borrowers – all can receive credit ratings from various institutions.
We’ll focus on personal credit since we are concerned with residential mortgages.
For Mortgage Lenders, Banks and Brokers – we primarily focus on 3 Credit Bureau Agencies and their scores – Equifax, Transunion and Experian.
The scores all and usually vary. Some I’ve seen vary 100 point swings (usually to one agency reporting a collection or derogatory credit).
But WHY you ask?
Well – let’s dive in!
We mortgage lenders will use your middle of the three scores reporting (not the average).
If your 3 scores are 720, 735 and 738 – we’re going to base on decisions off of 735.
So what does the affect?
Scores can determine the interest rate, mortgage insurance rate (conventional loans) which programs you qualify for and possibly the rate on your homeowner’s insurance policy.
Many times I’m asked – “Why does CreditKarma say my score is 760 but you’re telling me it is a 700?”
The online credit score companies typically don’t pull your actual scores but use what is on your report to calculate what that they think the bureaus are calculating. Because they don’t use the same algorithms that the bureaus use and don’t use all the same reporting information – the scores are almost always inflated from my experience.
So what do the bureaus use?
First, they look at how long you have had credit.
Newer borrowers with new credit (recently opened a credit card) typically start out in the high 600s/low 700s. This is due to lack of history of borrowing and payment history.
Second, they look at revolving credit and utilization. These are your credit cards, store cards, Home Equity Loans(lines of credit/HELOCs), etc. Your payment typically varies depending on the balance on the account. You will usually have a credit limit (Most AMEX cards are expected to be paid in full every month and are treated a bit differently). Based on that limit, your score will be cased on a tiered system of utilization. Those tiers are (listed as most impactful to most helpful):
- Balance Over limit
- Balance over 75%
- Balance over 50%
- Balance over 25%
- $0 balance (or $25 or less)
Typically, when we see low scores but only due to high balances; scores can be improved quickly – sometimes as little as 7 business days by paying them down and updating bureaus with new balances.
We also see scores be slightly better if there are small balances on a couple of credit cards versus $0 balances on all of them.
To be continued…