Credit Scores and Mortgage Loans15 May Brenda Warner
After a few late payments, you may wonder what the impact is on your credit report and your credit score. Whether you have lost a job, gone through divorce, lost a spouse, or dealt with a serious medical issue, you know that any hardship can wreak havoc on your financial responsibilities. You are not alone. More than 43 million people in the United States have credit issues that are severe enough to make obtaining credit with reasonable terms very difficult. If you want to repair your credit and improve your score, there are some things that you should understand.
Understanding your credit report and your credit score is very important when you want to get credit. There is different credit scoring models used today depending on what type of credit you are applying for. The important thing to understand about these scoring models is that regardless of what type of credit you are applying for, the human element to judge character and creditworthiness is removed from the transaction. Mortgage credit scores typically range between 350 - 800. If you are looking to buy a car, auto credit scores range between 250 - 900. If you are looking to purchase household furniture or other goods, a consumer credit score is between 300 - 900.
In the finance world, especially the mortgage industry, a lot of Federal regulation has been implemented that has caused the banks to severely tighten their credit standards and the regulations in 2011 are just as tight as they were last year. The economy, with its high unemployment rates and increased cost of living has made it virtually impossible for the average person to maintain perfect credit. The sum of this equation has about 40% of the people who are trying to qualify for a home loan being denied a mortgage.
Most lenders today require a minimum credit score of 640 to get approved for a mortgage loan. What this means is that out of the 3 credit bureaus, your middle score must equal or exceed 640. While some lenders may deviate from this standard rule, they don't without a cost. You may have to pay a higher interest rate, come up with a larger down payment and they may require that you have enough reserves in the bank to cover several mortgage payments. So, while banks may advertise that they lend on lower scores, beware of what it will cost you. Additionally, banks don't want to lend credit to those with a lower score than 640 because it is harder for them to sell the loan to another bank, so they only want to finance loans that are marketable.
Conventional FHA/VA Financing
If you are applying for a conventional mortgage, your credit is most likely in good standing. Conventional loans are typically for borrowers that have a sizeable down payment and a good credit score. While many lenders issuing conventional loans require a credit score of 660, ideally they look for scores of 720 or higher. Additionally, they look for a minimum down payment of at least 5% of the sales price. Most conventional loans are underwritten by Fannie Mae and Freddie Mac, so the higher your credit score, the more favorable credit terms you will get. In today's market, you don't see too many conventional loans being issued, especially without private mortgage insurance. If your credit score meets the requirements and you have a down payment of 20% of the purchase price, you can obtain a conventional loan without private mortgage insurance.
If you've had a few dings on your credit report and you know your score doesn't top the chart, you can apply for an FHA loan. While FHA doesn't issue loans, they insure them; their credit requirements are not as stringent. However, the lenders who are granting FHA loans may impose their own credit standards in order to better protect themselves from losses and to be able to better sell the mortgages on the secondary market. In the fall of 2010, HUD established some new credit score requirements. Borrowers with credit scores of 580 or higher were eligible for maximum financing (97.5%). Borrowers with credit scores between 500 - 579 were eligible for 90% financing and borrowers with scores below 500 were not eligible. While FHA has their guidelines, banks have theirs and in today's market most lenders are only willing to finance FHA loans to borrowers with a credit score of 640 or higher.
The VA insures loans to veterans and active military personnel. Lenders that issue VA loans will provide 100% financing and look for credit scores of 620 or higher.
OK, so what do you need to do to get your credit score up so you can qualify for your dream home?
The first thing to do is get a copy of your credit report. You can get a free copy of your credit report from each o f the 3 credit bureaus annually, however if you want your FICO score, you generally have to pay a fee. You can also ask a lender to pull your credit as well, and they can give you your FICO scores for free, but keep in mind that that credit inquiry will have an impact on your score.
We're going to take a look at what components makes up your score and give you some tips on how you can raise your score in the fastest amount of time.
Past delinquencies weigh the most heavily on your total score, which probably makes you think you should pay off all past delinquent accounts. This is not necessarily so. We mentioned in a previous article, 'Credit Reports and Repair', depending on the age of older past due delinquent accounts, it isn't always best to pay them off. Bad debts can only stay on your credit report a maximum of 7 years from the date of last activity. If you pay them off, the account will show paid, but the derogatory status remains and the account will now stay on your report for a maximum of 7 years from the date you paid it off. Therefore, check the dates on older past due accounts, charge-offs or collections. If the accounts are from several years ago, they will fall off your report on their own soon enough. Remember, the maximum amount of time information can remain on your report is 7 years. It doesn't mean they willstay on there for 7 years. If you have extra money and you want to use it to better your credit score, you can pay off some recent charge-offs or collection accounts. While the derogatory status will stay, the account will show paid. Once older past due accounts drop off your report, your score will automatically improve.
The next big bang on your credit report is your revolving credit debt ratio. There are a lot of myths about credit cards and how they impact your credit score. Some people think you should only have a couple of credit cards, others think you should combine all credit cards balances into one credit card balance. Some people don't think you should have high credit limits and some people think if you have a lot of credit cards, but don't use them, you should cancel them. Finally, some people think if you pay off your credit card every month, you won't establish credit. All of these are myths. The longer you have had a revolving account in good standing, the better impact it makes on your score. Remember average age of a credit file is 15% of your credit score. Keep those old accounts open! If you have one or more credit cards with high credit limits and manage them wisely, high credit limits can actually be advantageous. If you have several different types of credit cards, including department stores, keep them open. Closing credit card accounts can actually lower your score. But be aware, lenders have started cancelling inactive accounts or lowering credit limits on inactive credit card accounts. 30% of your credit score is determined by your debt-to-credit ratio. The lower your ratio, the better! Therefore, if you have cards that have a high credit limit, but you use the cards conservatively and keep small balances, it improves your score. The rule of thumb is to keep credit card balances less than 30% of the credit limit. For example, if you have a credit card with a $1000 credit limit, you want to keep the balance on that account less than $300. The more credit cards you have with a limit and the smaller the balance you keep on those cards, the lower your debt-to-credit ratio is. If you have 'maxed' out your credit cards and your debt-to-credit ratio is 95 - 10%, the best way to improve your credit score is to work hard to get the balances down below 30% of the limit.
The older your credit history is the better. The longer you keep and maintain accounts in good standing, the more positively it impacts your score. If you have a credit card account that has been opened for 10 years, don't stop using the card or the issuer might decide to close the account or stop reporting to the credit bureau. While the information might still be available, it won't add as much weight to your score. So keep older card accounts active even if it means charging a recurring monthly bill to the account and then paying it off each of month.
While the mix of credit you have on your file only makes up 10% of your total score, it is important for lenders to see how you handle different types of credit. If you are trying to build new credit, one of the best ways is to take out an installment loan. This might be for a car or household goods. Showing that you can make regular monthly payments over time is very important.
Finally we get to inquiries, which also make up 10% of your score. There are two types of inquiries: Hard inquiries and soft inquiries. If you are requesting your own annual credit report or applying for a job and your potential employer is pulling your report, these are soft inquiries and do not impact your score, however, hard inquiries do. If you are shopping for a new car and go to 3 or 4 different car dealerships and each one runs a report, it will impact your credit score. However, the credit bureau system detects the similarities in reports pulled and the 3 or 4 reports will count as only one inquiry. The same happens if you are shopping for a home loan. If 3 different mortgage lenders run your report, it will count as one inquiry. Where inquiries really begin to hurt your score is when you apply for various types of credit in a short period of time. If you are trying to apply for credit cards and buy a car and a house at the same time, the inquiries will not only lower your score, but raise a red flag for lenders!
In summary, we mentioned the following points that can help improve your credit score:
•If you have old past due accounts, leave them alone. Let them age and fall off your report on their own.
•If you do have past due or delinquent accounts that are current, you can pay them off. The derogatory information remains, but the status changes to paid. While this does not impact your score, it is beneficial.
•Pay down your credit cards. Lenders like to see a big gap between your balance and your credit limit. While it makes sense financially to pay down high interest cards first, if you are looking to raise your credit score, it is best to pay down the cards that are closest to their limit! Work to keep a low debt-to-credit ratio on all of your revolving credit card accounts. Keep long standing accounts active, keep high balance accounts open, but use your cards conservatively so your debt-to-credit ratio stays low. If you have high balances on your credit card accounts, you will be most rewarded by paying the balances down until they are less than 30% of the credit limit. This is where you will get the biggest bang for your buck.
•There are a few other things you can do to improve your score:
•If you have accounts that are old and due to fall off your report soon, you can contact the credit bureau to dispute the account. If it is old and has a small balance, there is a good chance the collection agency won't dispute the charge and it will be removed.
•Look for errors on your credit report. If you see accounts that are not yours, dispute them. 70% of the credit reports have errors on them. The chances of there being an error on your report are good. So review your report and if there are errors, dispute them to have them removed.
•Old, past due accounts don't get discarded because you have new, current accounts. Sometimes time is required to raise your score. Let old bad debts just fall off when they've aged. To mess with them will add 7 more years of derogatory information.
•There are a few other things you can do to increase the improvement. If you have accounts that are old and due to fall off your report soon, you can contact the credit bureau to dispute the account. If it is old and has a small balance, there is a good chance the collection agency won't want to dispute the charge and it will be removed.
Other things to consider:
•Your credit score is based on the information in your credit report, so check for errors. Some of these errors can really hurt you, so review your credit report thoroughly and look for any errors in the following areas:
•Correct any late payments, charge-offs, collections or other negative items on your report that are not yours.
•Correct any credit limits that are incorrect. If your credit card company has reported a credit limit lower than what it actually is, get it fixed.
•Correct any accounts that may be listed as "settled," "paid derogatory," "paid charge-off" if you paid them on time and in full.
•Correct any accounts that are still listed as unpaid that were included in a bankruptcy.
•Negative items older than seven years (10 in the case of bankruptcy) that should have automatically fallen off your reports.
•If you've closed accounts and they still show open, don't correct this. Closing accounts can actually lower your score.
•If you are trying to establish credit because you have not credit, apply for a credit card. Charge something small each month, such as a tank of gas or dinner, and pay it off each month. After establishing some credit with a credit card company, apply for an installment loan. It can be a simple personal loan that you can pay off in 12 months. You want to do this to build a mix into your credit file.
•Avoid these common credit mistakes when you are trying to improve your credit scores:
•Don't ask a credit to lower your credit limit because it reduces the gap between your balances and your available credit. The lower the gap, the more it hurts your scores.
•Avoid making late payments. While a missed or late payment will do more damage to a good credit score than it will an already low score, you definitely want to avoid missed or late payments if you are trying to improve your score.
•If you are trying to improve your scores, applying for a new account or additional credit when you already have enough credit can ding your scores, unless you are recovering from a bankruptcy. In this case, applying for an installment loan can help.
•Don't transfer credit card balances from a high-limit card to a lower-limit one or transfer small balances to a high limit card. It's better to have smaller balances on a few cards than a big balance on one. Remember the debt-to-credit ratio.
•Having good credit and being an educated consumer can save you money. You will get better interest rates and better terms, which saves a lot of money in the long run. Additionally, you can save money on insurance. Know what is in your credit report and know what your score is. Lenders are in business to make money. If you don't know what's in your credit report or what your score is, a lender can charge you more. Understanding what's in your credit report and knowing what your score is can give you bargaining power when negotiating interest rates and terms.