You may have heard of credit scores and wonder what they are. These “scores” affect your ability to get a loan, the interest rate and points you will pay. You may also wonder whether your credit score is accurate. The following explains credit scores and how to improve your score.
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 as consistent as possible. In an effort to achieve these goals, mortgage lenders recently began using credit scores to help in the underwriting process. 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.
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 will be made based on sound, flexible underwriting guidelines.
What is a FICO Score?
“FICO” scores are a type of credit score developed by 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. FICO scores range from approximately 350 to 900. The higher the score the less risk.
How 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 the mortgage banker.
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 part of 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.
Factors include:
- The type of property securing the loan
- The amount of the borrower’s equity in the property
- The lender’s costs to make the loan
- The type of loan selected. For example: 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, a greater incentive to make the payments on the loan.
How to Improve Your Credit Score
- By Making Timely Payments (delinquencies, foreclosures, bankruptcies, and judgments will decrease your score)
- The Number of Trade Lines: this is your number of credit cards. Limit it to only a few and be sure to pay them on time.
- Avoid High Credit Limits: Lenders also consider the amount of credit available 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. The lower the better.
How To Correct Mistakes on Your Credit Report
Because credit scores are based upon your credit record, it is very important that you obtain 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 you may have their credit mixed up with yours), you should immediately take steps to get it corrected. No one can do this but you.
Be sure cover to all your bases by contacting all three major credit bureaus. Information from one may not be complete from just one.
Equifax: 800-685-1111
TransUnion: 610-690-4909
Experian (TRW): 800-682-7654
In most cases, your loan officer will give you a copy of your report and go over it with you. If you find errors on your credit report, the loan officer we work with will assist you in fixing them. This is why it is important to select a well respected person to guide you through this process.
