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 consistent as possible. In an effort to achieve
these goals, mortgage lenders recently began using credit
scores to help in the underwriting process. Credit
scores are numerical values that rank individual's according
to their credit history at a given point in time. 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. According to Fannie
Mae and Freddie Mac, two of the largest purchasers of home
loans from lenders, credit scores have proven to be very
good predictors of whether a borrower will repay his or
her loan.
Many lenders use credit scores to help evaluate loan applications. However,
a credit score is just one of many factors considered in
the underwriting process. Lenders look at the entire
picture. 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 may be made based on
sound, flexible underwriting guidelines.
What Is A FICO Score?
"FICO" scores are a type of credit score developed
by a 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. Millions
of consumers' credit bureau records were used to develop
the scorecards, and all of the consumer data - not just
negative information - was included to develop the system. FICO
scores range from approximately 350 to 900. The
higher the score the more likely someone is to make their
payments. Similarly, the lower the score the more
likely someone is not to make their payments.
How Can 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 a mortgage broker. The price charged for a
loan will be higher or lower depending on various factors.
Credit scores are used in determining the price of a loan
because they are believed to be good predictors of the
borrowers ability and willingness to repay a loan. 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 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.
There are many other factors relating to an individual
borrowers situation that may also affect the price of a
loan, often even more so than credit scores. These
include: the type of property securing the loan (detached
single family residence, duplex, etc.); the amount of the
borrower's equity in the property; the lenders costs to
make the loan; and the type of loan selected. For
example, a loan secured by a single family residence may
have a lower price than a loan secured by a duplex because
duplexes are more difficult to sell than single family
residences. Similarly, 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, the greater incentive to make the payments on the
loan.
How to improve your credit score?
Because each borrower's credit score is a reflection
of his or her unique credit profile, it is not possible
to quantify in advance exactly how each item in your
credit history numerically impacts upon your ultimate
credit score. No
one can tell you, for example, how much your credit score
will be affected if you pay off a delinquent account or
cancel a credit card. We do know, however, that
there are things you can do to improve your credit profile. Some
of the factors which may impact your credit scores include:
• Making timely payments: Making your payments on time is the best
way to increase your score. Delinquency, foreclosures, bankruptcies
and judgments will decrease your score.
• Limit the number of trade lines: The number of credit cards, lines
of credit and other types of credit (" trade lines ") you have available
will affect your score. If you have a lot of trade lines, this may decrease
your score because of the risk that you might not be able to pay off all of your
accounts, and this may affect your ability to pay off your mortgage loan. You
may wish to consider canceling credit cards you do not use regularly or choosing
2 to 4 cards to use and canceling the rest. If you close or cancel an account
voluntarily, it will not have a negative effect on your credit score. You
may wish to reconsider accepting "pre-approved" offers for your credit
cards, or if you accept an offer, perhaps you should cancel another credit card. On
the other hand, if you have no trade lines, this will likely decrease your score. Lenders
generally want to see that you have some available credit and that you can
handle your credit wisely.
• Avoid unnecessarily high credit limits: Lenders also consider the
amount of credit available to you (your credit limit) 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. In general, the lower the amount
outstanding, the more likely it is that your score will be higher.
• Do not apply for credit you do not need: Whenever you apply
for credit, the creditor will obtain a credit report from one or more of the
three credit bureaus. Each such credit inquiry will stay on your record
and will affect your credit score. Even if you are turned down for
credit or change your mind and withdraw your application, your credit score will
be affected. This is because each inquiry suggests that you are increasing
the amount of credit available to you. Before you give your Social Security
number to anyone, make certain you know how they are going to use it. A
Social Security number is almost always required to run a credit report. But
don't let the fear of inquiries stop you from shopping for the best deal when
you need auto or home financing. Recently, the credit bureaus have recognized
that borrowers may apply for credit at more than one place for the same transaction. Generally,
the credit scoring companies will consider all auto or mortgage loan inquiries
received it in a 14 day period as one inquiry so the additional inquiries will
not affect your credit score. And remember, if you order a copy of
your credit report to make sure it is accurate, this will not show up as
an inquiry on your record.
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How To Correct Mistakes On Your Credit Report:
Because credit scores are based upon your credit record,
it is very important that you obtained 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 yours may have
their credit mixed up with yours), you should immediately
take steps to get it corrected. No one can do this
but you.
Lenders, credit card issuers and other credit providers
send regular reports about their accounts to the major
credit bureaus. This is where the information on
your credit report comes from. There are three major
credit bureaus; you should contact each one because not
all credit providers report to each bureau. Also,
if you have a joint credit (for example, if you are married
and have joint accounts with your spouse), it is a good
idea to get the credit report for each of you because there
may be information on one report that does not appear on
the other. If you ask for a copy of your credit report
to check your credit history, it will not affect your credit
score. You can reach the 3 credit bureaus at the
following phone numbers:
In most cases, there is a small charge to obtain a copy
of your credit report. If you find errors on your
credit report, follow the directions included with your
credit report regarding disputes or errors. Generally,
you must write the credit bureau and advise them of the
error or dispute. You may need to provide proof that
the bill was paid or other information about the claim
or dispute. The credit bureau will then contact the
provider of credit who reported the information, and the
provider will have 30 days to respond. If the provider
of credit agrees that there is an error, it will instruct
the credit bureau to delete the item from your credit report.
You should allow at least 30 days after you have notified
a credit bureau of an error in your credit report for that
error to be investigated and resolved. It may take
longer depending upon the nature of the error and the investigation
to be done.
