Credit scores (FICO scores) are a number based on a formula that summarizes someone's credit accounts, debt ratio and payment history.
And that number really matters when someone applies for a loan.
Credit scores don't just determine someone's ability to qualify for a loan. Credit scores will drive the terms of the loan, including the required down payment and interest rate.
Disclaimer: I am not a mortgage broker. I am a real estate broker. That said, it is hard to do what we do for a living without a basic understanding of home mortgage loans. The information presented here was gathered from conversations with loan officers and various searches of home mortgage and credit agency web sites and is being shared here as a starting point for you to understand credit scores and loans. Further consultation with a professional mortgage loan officer is recommended.
Credit Scores range from 300 to 850 and generally speaking, the higher someone's score, the more money they will be approved to borrow (providing they have the income to afford the payments) and the less interest they will pay over the length of the loan.
The general range looks like this:
- 800-850: This is basically flawless credit. Buyers with scores in this range can buy just about anything they want on credit as long as they have the income to make the payments.
- 720-799: This is considered excellent credit, and buyers with scores in this range should qualify for the best interest rates available.
- 680-719: This is considered good credit. Buyers should still be able to qualify for most loans, although the interest rates may be a little higher than those offered to borrowers with excellent credit.
- 620-679: Credit scores in this range are still considered “OK” by many creditors, though buyers will not qualify for the best rates advertised and there may be challenges getting loan approval as a result of further restrictions.
- 580-619: This is where “OK” and “good” turn to “bad”. Buyers may have a difficult time obtaining a loan.
- 500-579: Credit scores in this range are just flat out ugly. There’s a good chance these buyers have a major issue like a judgment, collection, late mortgage payments, a short sale, foreclosure or bankruptcy.
- < 500: Credit scores below 500 are the worst of the worst. These buyers are in serious need of financial counselling and will be forced to look to the rental market for housing.
According to the agencies, this is what they look at to determine score:
- 35 percent is determined by a borrower's payment history. Paying bills on time is great. Late payments are not great. Missing payments completely...that's trouble.
- 30 percent is based on the amounts owed to creditors, as well as how that compares with the total credit limit on the account. Owing $300,000 on a home mortgage that was originally issued for $600,000 is much better than owing $24,500 on a credit card with a $25,000 limit. 15 percent is based on the length of credit history. It is better to have fewer, older accounts as compared to a large number of new accounts.
- 10 percent is based on how many accounts the borrower has recently opened compared with the total number of open accounts.
- 10 percent is determined by the types of credit used. Installment debt — like a mortgage, demonstrates the ability to manage a large loan. Revolving debt, like credit cards, will carry more weight since they are often predictors of future behavior.
Credit Scores can drop if a borrower applies for several loans, credit cards or lines of credit all at once — a sign of potential financial trouble. That is why lenders instruct borrowers NOT to buy a car or open a new credit card account while a new home loan is being reviewed in underwriting.
Shopping for (and comparing) mortgage rates from multiple lenders typically will not affect scores (if all inquiries are within 6 weeks).
The best way to achieve a higher score, or improve a lower one, is to:
- Make sure to pay bills on time.
- Maintain at least one credit account that has been open for a long time.
- Keep credit card balances low (under 1/2 of the total credit limit) or better yet... zero.
- Review the credit report often.
Advise your buyers that they can get a free copy of their credit report from each of the three major credit agencies once a year. They can order it through AnnualCreditReport.com, which is the only authorized online site under federal law. To access credit scores more than once per year, there will typically be a charge. Search www.Google.com for "credit report". There are dozens of sources. Some will be free, others will charge a small fee.
When it comes to qualifying buyer clients for a mortgage, credit scores are a huge factor. Use this information to help your client understand the importance of their score and how it is used to provide pre-approvals.
To your success,