This Week’s Highlights:
- Credit Scores: The Third Part to Mortgage Lending
- The Ingredients of Your Credit Score
- It’s Never Too Early to Start Preparing
Credit Scores: The Third Part to Mortgage Lending
Mortgage lending can be thought of as a three-legged stool.
- One of the legs would be income. Maybe you’re self-employed or paid by a family member.
- The second leg would be down payments, or how much you can pay upfront when buying a new home.
- The third leg is credit scores. This might be the least talked about aspect of mortgage lending, and this relates to how you are measured at paying back other bills.
A recent front-page Wall Street Journal article reported that there are 53 million U.S. adults who don’t have enough information in their credit reports to generate an accurate credit score.
In response, banks are attempting to come up with their own “additional factors scoring models” that include things like going beyond what’s in a credit report, the amount of money in a bank account, or how many times an account has been overdrawn in the last 12 months.
While these banks are trying to deepen the pool of applicants to whom they can lend money, their primary focus is on car loans and credit cards as opposed to mortgages.
The universal credit score that most lenders look at when assessing a borrower’s credit risk is the FICO score (Fair IsaacCorporation). First utilized in 1989, this three-digit number is used to predict the likelihood of a borrower’s ability to pay back that next debt.
FICO sells 27.4 million FICO scores a day — twice as many cups of coffee sold at Starbucks in a day. In other words, FICO sells four times as many scores as McDonald’s sells hamburgers in a year.
But not all credit reports are created equal. Credit Karma uses a vantage score of 3.0, which is a competitor to the FICO score model. First introduced by TransUnion and Equifax, the Credit Karma report has a cap of 900 as opposed to FICO’s 850. While still relevant, the 900 score cap is not utilized by lenders when considering applicants for various loan types.
This can be confusing to potential borrowers — especially when checking their credit scores through competitors like Credit Karma — because your score does impact the interest rate and the closing costs you get on your mortgage.
The 5 Key Ingredients of Your Credit Score
There are five key components to your FICO score. Or in other words, consider it as a sort of “credit- recipe.”
Here’s the basic credit score recipe:
1- 35% of your credit score is dependent on your payment history. When trying to predict whether or not you’re going to pay back the next loan, your history of paying back other loans will naturally be front and center.
This aspect also includes certain little nuances that many people don’t consider. For example, if you have a very recent late payment, it’ll hurt your score more than a late payment from years earlier.
2 – 10% of your FICO credit score is the mix of your credit accounts. There are three different types of credit mortgage installments (including student loans). Your FICO score will be higher if you:
- Have a mortgage
- Have a car loan or lease
- Have at least one credit card active
When this revolving debt is being paid off in a timely manner, this will be reflected positively in your FICO credit score.
3 – Another 10% of the FICO score is new credit. If a potential borrower is applying for a lot of credit in a short period of time, they’re going to get dinged on their credit score.
But if that same borrower is shopping for a car and they have their credit checked numerous times within a two-week period, it only counts as one inquiry. The same thing goes for shopping for a mortgage. Even if it’s run numerous times, the credit scoring system will consider that to be one active credit inquiry.
It’s important to realize that this credit score aspect is something that can be controlled by the borrower. While having your credit checked several times for a mortgage is considered one active inquiry, shopping for a car at the same time will open another inquiry and will ultimately end up having a negative impact on the score.
4 – 15% of your credit score comes from the length of your credit history. While this aspect can’t really be changed, it essentially means the older you are and the longer you keep a positive track record, the higher your credit score is going to be.
5 – The last ingredient of the FICO credit score is one that most people tend to be the least aware of — Credit utilization. The percentage of your credit utilization score — also often referred to as your debt to income ratio — examines the amounts still owed in terms of debt.
For example, let’s say you only have one line of credit that maxes out at $5,000 — a single credit card. Now, if your balance on this card is at $4,900, this is 98% of your total credit limit. Lenders will look at this and rate you lower in this rating factor.
However, if you are only using 30% or less of your total credit limit, your credit score will improve. In the above example, this would be no more than $1,500 on your $5,000-limit card. In reality, most people have more than one line of credit, and while these are all factored together, the same math applies to your entire line of credit universe.
This is something that potential borrowers can manipulate in their favor. Lenders like Accunet use something called a “What If” tool that allows us to essentially crack open the hood on a borrower’s existing credit report and figure out what options are available to raise the score and get a better mortgage deal.
It’s Never Too Early to Start Preparing
We recently spoke with a younger couple with two small children and one on the way. This couple wanted to start actively looking for a new home. They currently own a home that is completely paid off — literally “mortgage-free” — and they’re looking in three specific high school areas with good ratings. Their intent is to send their kids to better schools in 8 or 10 years once they are finished with middle school.
We suggested that they set up a loan on their existing house, even though they own it free and clear. No one can predict when that perfect home comes on the market, and setting up a line of credit on that existing home helps to ensure that you have the ability to make a substantial down payment in the future for a new home. It’s a good idea to roll at least some of that equity over into the new home, instead of suddenly scrambling at the last minute to figure out where the down payment will come from.
When preparing to shop for a new home, it’s important to make sure you have all of your ducks in a row, especially in a market as hot as this one. At Accunet, we want to ensure that you can rest easy with a Rock-Solid Pre-Approval.
The experts at Accunet Mortgage and Realty have helped hundreds of people in similar situations and truly believe in the importance of being prepared as early as possible and armed with all viable options so that when that perfect home does come along, you can get it without worrying about making ends meet in the future.
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