Bruce Specter offers this information as a guide to the often confusing world of credit and how it affects us in the mortgage process.  Credit is the key to securing financing.  If you have perfect credit, it is your responsibility to make sure your hard work does not fall prey to fraud.  If you have less than perfect credit, this is information is provided as a guide, as well as path to home ownership.   Contact Bruce Specter at any time for additional information on any of these topics.

Credit Scoring In the Mortgage Industry

Your Credit Score Isn't a Numbers Game

Understanding How Bad Credit Affects Mortgage Qualification

Less Than Perfect Credit

Credit-Damaged Borrowers CAN Obtain Home Loans

Sub-Prime Loans

Credit Scoring In The Mortgage Industry

Ten years ago, credit scoring had little to do with mortgage lending. When reviewing the credit worthiness of a borrower, an underwriter would make a subjective decision based on past payment history.

Then things changed.

Lenders studied the relationship between credit scores and mortgage delinquencies. There was a definite relationship. Almost half of those borrowers with FICO scores below 550 became ninety days delinquent at least once during their mortgage. On the other hand, only two out of every 10,000 borrowers with FICO scores above eight hundred became delinquent.

So lenders began to take a closer look at FICO scores and this is what they found out. The chart below shows the likelihood of a ninety day delinquency for specific FICO scores.

(NOTE: Be wary of the numerous credit report companies offering full reports and misleading credit scores. Most, if not all, of these 3rd party companies are not providing you with your actual FICO score.

Credit scores used by credit grantors are only derived directly from the 3 major credit reporting bureaus: Equifax, Experian (TRW), and TransUnion.  If you want accurate information with an accurate score, only purchase direct from these 3 major reporting bureaus.)

If you were lending a couple hundred thousand dollars, who would you want to lend it to?

Imagine a busy lending office and a loan officer has just ordered a credit report. He hears the whir of the laser printer and he knows the pages of the credit report are going to start spitting out in just a second. There is a moment of tension in the air. He watches the pages stack up in the collection tray, but he waits to pick them up until all of the pages are finished printing. FICO scores are located at the end of the report, which is why he waits. Previously, he would have probably picked them up as they came off. A FICO above 700 will evoke a smile, then a grin, perhaps a shout and a "victory" style arm pump in the air. A score below 600 will definitely result in a frown, a furrowed brow, and concern.

FICO stands for Fair Isaac & Company, and credit scores are reported by each of the three major credit bureaus: TRW (Experian), Equifax, and Trans-Union. The score does not come up exactly the same on each bureau because each bureau places a slightly different emphasis on different items. Scores range from 365 to 840.

Some of the things that affect your FICO scores:

• Delinquencies
• Too many accounts opened within the last twelve months
• Short credit history
• Balances on revolving credit are near the maximum limits
• Public records, such as tax liens, judgments, or bankruptcies
• No recent credit card balances
• Too many recent credit inquiries
• Too few revolving accounts
• Too many revolving accounts

Sounds confusing, doesn't it?

The credit score is actually calculated using a "scorecard" where you receive points for certain things. Creditors and lenders who view your credit report do not get to see the scorecard, so they do not know exactly how your score was calculated. They just see the final scores.

Basic guidelines on how to view the FICO scores vary a little from lender to lender. Usually, a score above 680 will require a very basic review of the entire loan package. Scores between 640 and 680 require more thorough underwriting. Once a score gets below 640, an underwriter will look at a loan application with a more cautious approach. Many lenders will not even consider a loan with a FICO score below 600, some as high as 620.

Credit scores can affect more than whether your loan gets approved or not. They can also affect how much you pay for your loan, too. Some lenders establish a "base price" and will reduce the points on a loan if the credit score is above a certain level. For example, one major national lender reduces the cost of a loan by a quarter point if the FICO score is greater than 725. If it is between 700 and 724, they will reduce the cost by one-eighth of a point. A point is equal to one percent of the loan amount.

There are other lenders who do it in reverse. They establish their base price, but instead of reducing the cost for good FICO scores, they "add on" costs for lower FICO scores. The results from either method would work out to be approximately the same interest rate. It is just that the second way "looks" better when you are quoting interest rates on a rate sheet or in an advertisement.

FICO scores are only "guidelines" and factors other than FICO scores affect underwriting decisions. Some examples of compensating factors that will make an underwriter more lenient toward lower FICO scores can be a larger down payment, low debt-to-income ratios, an excellent history of saving money, and others. There also may be a reasonable explanation for items on the credit history which negatively impact your credit score.

Even so, sometimes credit scores do not seem to make any sense at all. One borrower with a completely flawless credit history had a FICO score below 600. One borrower with a foreclosure on her credit report had a FICO above 780.

Finally, there are a few "portfolio" lenders who do not even look at credit scoring, at least on their portfolio loans. A portfolio lender is usually a savings & loan institution who originates some adjustable rate mortgages that they intend to keep in their own portfolio instead of selling them in the secondary mortgage market. They may look at home loans differently. Some concentrate on the value of the home. Some may concentrate more on the savings history of the borrower. There are also "sub-prime" lenders, or "B & C paper" lenders, who will provide a home loan, but at a higher interest rate and cost.

One thing to remember when you are shopping for a home loan is that you should not let numerous mortgage lenders run credit reports on you. Wait until you have a reasonable expectation that they are the lender you are going to use to obtain your home loan. Not only will you have to explain any credit inquiries in the last ninety days, but numerous inquiries will lower your FICO score by a small amount. This may not matter if your FICO is 780, but it would matter to you if it is 642.

In conclusion, a word of advice not directly related to FICO scores. When people begin to think about the possibility of buying a home, they often think about buying other big-ticket items, such as cars. Quite often when someone asks a lender to prequalify them for a home loan there is a brand new car payment on the credit report. Often, they would have qualified in their anticipated price range except that the new car payment has raised their debt-to-income ratio, lowering their maximum purchase price. Sometimes they have bought the car so recently that the new loan doesn't even show up on the credit report yet, but with six to eight credit inquiries from car dealers and automobile finance companies it is kind of obvious. Almost every time you sit down in a car dealership, it generates two inquiries into your credit.

Nowadays, credit scores are important if you want to get the best interest rate available. Protect your FICO score. Do not open new revolving accounts needlessly. Do not fill out credit applications needlessly. Do not keep your credit cards nearly maxed out. Always make sure every creditor has their payment in their office no later than 29 days past due. And never ever be more than thirty days late on your mortgage.

Your Credit Score Isn't a Numbers Game

Let's say you've never missed a mortgage payment, you've never been late on your credit cards and are generally considered a no-risk, A-1 credit consumer.

You want to refinance your mortgage, but when the lender pulls your credit score you fall below the magic mark. So you decide to "fix" your credit rating by paying off some small balances on high-limit credit cards. Your broker suggests you cancel those cards and shift the balance, thousands of dollars, onto fewer cards in an effort to show meaningful consolidation.

You apply again but score even lower.

As word gets out that more and more lenders use credit scoring to swiftly qualify applicants, uninformed consumers who try to beat the system could end up with results that are the opposite of what they hoped for.

Offering the widely used "FICO" credit-scoring system, San Rafael-based Fair, Isaac and Co. scores range from a low in the 300s to a high above 800. The score represents a statistical evaluation of how likely you are to default on a loan. The higher the score, the lower the probability you'll default.

The lender requests the score as part of the credit report it obtains from one or more of the three national credit bureaus: Equifax, Experian and Trans Union. Fair, Isaac's statistical-modeling software crunches the numbers from your credit report data to come up with a score.

Some lenders rely more heavily on credit scoring than others. While it can speed up your loan application, it can also reject it. It is, after all, only a computer-generated number and the best lenders consider additional factors.

For instance, suddenly canceling many cards with small balances and then shifting all the debt to fewer cards effectively raises the ratio of your unpaid balances to the maximum credit lines available on fewer cards. To the software, it appears as if your financial situation has tightened.

Quick fixes won't get you the loan, but there are some strategies to get you the highest score possible.

·         Periodically keep tabs on your credit report for inaccuracies, especially several weeks before you apply for a large loan, including a mortgage. Obtain your report from one or all of the three credit reporting agencies or obtain all three from Web sites like Oakland, CA-based QSpace Inc.'s iCreditReport. Fair Isaac's Web site can tell you how to handle derogatory remarks.

• Pay all your bills on time. Lateness, collections, bankruptcies weight most heavily against your credit score.
• Use credit wisely. That means use only the credit you need and can afford to pay.
• Don't max out your credit cards. Keep balances low.
• Don't apply for or open many credit accounts in a short period of time.
• Don't try to change a score overnight by suddenly closing or opening accounts. Scores are based on complex statistical models that could make such actions backfire.

Beware any credit counseling or repair service that promises to rid your credit record of late payments, past due accounts and other negatives, even when the black marks are legitimate.

They may be able to get derogatory items removed from your files, but only for a brief period. Within 30 days or so, the benchmarks by which your ability to handle credit issues are judged usually find their way back into your folder, and that can trip up a borrower who's about to close on a mortgage.

Sometimes known as credit doctors, these credit repair firms are successful in getting negative items removed because they flood credit bureaus with dispute letters on behalf of their clients. Under the law, the credit agency must respond to inquiries within 30 days or remove the disputed items from their records.

But these scam artists don't deal with creditors, who are the source of the data contained in your credit files. So when it comes time for the credit card company or department store to report late payers to credit bureaus, the disputed items once again become part of your record.

"Credit repair companies charge people a ton of money," says Eileen O'Neill of Gold Key Credit Consulting in Milford, Conn. "But if they don't take the consumer's beef to his creditor, it's a waste because the item pops back up again on the credit report."

You may qualify for a mortgage at a good rate while the items are gone from your records. But if they are back when the lender re-runs your credit score just prior to settlement, you could not only lose your rate, you may even lose your loan.

Here are a several other tips that might help you achieve a higher credit score:

Understanding How Bad Credit Affects Mortgage Qualifications

What's with American housing consumers' lack of knowledge about mortgages? Not two months ago Chicago-based Bank One reported that one in three home owners earning $50,000 or more believe the interest on equity loans isn't tax deductible or they don't know whether equity loan interest is tax deductible.

A new study now says half of American adults also misunderstand how bad credit affects their ability to qualify for a mortgage.

Fannie Mae's 1999 National Housing Survey reveals a more tolerant mortgage marketplace where barriers to home ownership have fallen since the early 1990s, but the organization's eighth annual survey also shows unexpected ignorance about bad credit.

"The high percentage of Americans who don't connect paying bills late with the potential for problems later when they try qualifying for a mortgage is a new and very disturbing trend, and we must find ways of reversing it," said Franklin D. Raines, chairman and chief executive officer of Fannie Mae.

• Only 15 percent of those surveyed said having high enough of a credit rating would be a major obstacle to home ownership for them, yet the study also revealed a lack of information about how to maintain a good credit rating.
• Thirty one percent of those surveyed said being late paying utility bills three times in the past year would be no problem at all in qualifying for a mortgage.
• Forty one percent said it would be a major problem, 32 percent said it would be a minor problem and 18 percent said it would be no problem at all if he or she was more than 90 days late, three times or more paying a utility bill.
• African Americans and Hispanics were more likely than whites to understand the consequences of late bill paying. While 62 percent of blacks and 46 percent of Hispanics understand it would be a major problem to be 30 days late paying a utility bill three or more times, only 38 percent of whites agreed.

Fannie Mae randomly surveyed 1,812 adults from April 30 to May 10, 1999 and 878 adults responded. The survey's accuracy is plus or minus 2.9 percent, it says.

"A shadow is falling across the otherwise positive news is how many Americans don't fully comprehend the relationship between paying bills late, having bad credit, and experiencing difficulties in qualifying for a mortgage," Raines said.

The survey also found:

• The percentage of Americans who say that having enough money for a down payment and closing costs is a major obstacle to their home buying prospects has fallen to just one American in four, compared to the average nearly one in two Americans who said it was an obstacle from 1992 to 1997.
• Only 23 percent of all adults said being able to find a home they like and can afford was a major obstacle to home ownership, compared to average 43.5 percent between 1994 and 1997.
• Three years ago, nearly half (48 percent) of all Americans said having enough confidence in job security was a major obstacle to owning a home. Today the number dropped to 13 percent.

"Fannie Mae's survey reveals a vibrant mortgage market place, with barriers to home ownership having fallen since early in the decade," Raines said.

Less Than Perfect Credit

Most Americans use credit to purchase goods and services. Typically, the largest purchase most families make -- a home -- is financed with a long term loan. From cars to stereos and from clothes to Friday night dinners, the use of credit is a common form of payment.

There are two major types of credit: installment and revolving. Installment credit is generally issued through financial institutions and is used to finance homes, autos, education, etc.  Revolving credit is issued by banks and retail stores through credit cards. In most forms of credit, the borrower agrees to make monthly payments on the loan until it is paid in full.

Sometimes, consumers find their financial situation has changed and monthly credit obligations have become difficult to meet. A job loss, chronic illness, divorce, etc. can all have an affect on an individual's ability to meet monthly payment obligations. Most Americans encounter difficult periods in their life that sometimes result in tarnished credit. Tarnished credit is reflected on a credit report as a slow payment history, collection, bankruptcy, repossession, or foreclosure.

Contrary to the beliefs of many consumers, tardy or tarnished credit does not necessarily preclude one from obtaining a loan to finance a home. Many times an experienced mortgage professional can help consumers with proper strategy needed to qualify for a mortgage loan. Mortgage lenders are in the business to make loans and will attempt diligently to help consumers obtain a mortgage to purchase of home.

Sometimes there may be an isolated blemish on an otherwise good credit record. In these cases, the mortgage lender will ask for a written statement explaining the reasons for the late payment. If the explanation is creditable, the infraction may not be held against the consumer. In other cases, the credit problem occurred sometime ago, but the consumer has reestablished credit. A letter of explanation coupled with excellent current credit may be more than adequate to meet home mortgage underwriting guidelines.

What is important is for consumers to work with an experienced loan officer to help determine your home mortgage eligibility. A loan officer can review your credit report and formulate a plan to bring the report into compliance for a home loan. Sometimes a letter of explanation with supporting documentation is sufficient. Other times the loan officer may suggest you pay off some debts and reestablished good credit over a period of time before buying a home. The most critical time period of your credit history is the proceeding twelve months.

I am armed with an arsenal of mortgage programs with varying degrees of credit grade requirements. Most times I am able to find a mortgage for a consumer even if their credit is very substandard.

The key is to not be discouraged and work with an experienced loan officer in developing a strategy. There are many ways I can help consumers work through credit problems and ultimately help them obtain of mortgage. Tarnished credit is not the end of the world.

Credit-Damaged Buyers CAN Obtain Home Loans

It's credit called by many names ranging from sub-prime, it's technical name to damaged, it's operative name. But in essence it means that even though a buyer has less-than-perfect credit, he can still obtain a less-than "A" grade loan---about the only type of risk-level mortgage available until a decade ago. Today, it's a whole new world. Many lenders have the ability to offer B, C, even D grade loans to credit-blemished borrowers' with a range of glitches from slow pays to bankruptcy!

Why are these loans vogue today and how do they work? The lending community, in a move to seize other streams of income, realizes that sub-prime loans are a potential customized growth industry (if the lender has the knowledge and desire to take them on since they can be problematic to rate and to package to sell to investors.) And second, lenders realize that heavy credit coupled with life situations out of a borrower's control like illness, divorce and death have made picture-perfect credit all but non-existent. Wanting to make loans to all types of borrowers, customized credit lends flexibility and greater "rule-of-thumb" reliability when evaluating less-than-perfect borrowers.

Are there general assumptions that lenders use to evaluate these credit situations? While all borrowers are evaluated on their own merits, most lenders want borrowers to have reasonably stable employment, fully documented income, assets, and liabilities with the purchase or refinance for a single family owner-occupied house or condo (not an income property). In other words, blemished credit requires a borrower to show a certain degree of personal stability even if his credit picture is marred.

Rated from A- to D, the higher the rating moves away from A, the higher the risk for the lender. For example, a "C" grade loan might go to a borrower who had as many as six late payments on installment debts (car payments) and four late payments on revolving accounts (like credit cards) during the last twelve months. Additionally, the borrower could have been late twice paying his mortgage! As you can see, that's considerably softer than required for traditional "A" grade loans.

Don't assume that sub-prime lenders will embrace borrowers who can't explain why they were late making payments, especially on a chronic basis. Lenders will still require verification of why slow payments occurred and what the borrower has done to prevent the situation from occurring in the future. While sub-prime loans do assist credit-blemished borrowers, it's imperative that consumers shop diligently with several lenders to obtain the best rates and fees even in a competitive lending market.

Being initially turned down for an "A" grade mortgage can find sub-prime borrowers jumping at the first lender willing to make a loan, causing them to overpay, exacerbating their marginal financial position. As with all potential loan products, comparing loan costs line-by-line for various programs through several prospective lenders will give the borrower the best comparison of the range of interest rates and points necessary to obtain this type of customized financing.

Sub-Prime Loans

So, you’ve read the newspapers, seen the articles, and talked to your friends....REAL ESTATE IS GOOD AGAIN. Home prices are on the rise, and you think maybe it is about time to take the plunge. Prices are still relatively low and now is a good time to buy. If you already own a home, you also know that mortgage interest rates are very low, and now could be a good time to refinance. Who wouldn’t want lower payments?

OK, this is a good idea. Only one small problem.....you have a few negative ratings on your credit report. You have even been down this road before, and the answers were all the same...NO.

Well, times have changed in the mortgage lending industry, and there may be a program for you, now.

Many lenders have adopted Sub-Prime Mortgage programs, and have the ability to fund loans for people with less than perfect credit. Let’s start here...what exactly is Sub-Prime?

Sub Prime can have two definitions...first, all residential loans that are generally not eligible for sale to FNMA, FHLMC, or the Jumbo Conduits (loans over $214,600) are considered sub-prime. Additionally, sub-prime is the term for any loan transaction where the borrower has had delinquencies on a regular or extensive basis. The credit is broken into three primary categories...Mortgage Credit, Consumer Credit, and Public Records.

The first one is obvious...your payment history on your existing, or previous mortgage. Obviously this relates to people who have owned a home before. The second category relates to credit cards, installment loans, student loans, and any other forms of debt. The third category relates to public records such as previous bankruptcies, judgments, foreclosures, etc.

Your lender will evaluate the nature of your current delinquencies, past lates, and Grade your credit. A borrower will typically fall into one of FIVE categories: A, A-, B, C, or D. The A borrower can have a 30 day late on the existing mortgage within the last 12 months. The D borrower could currently be in foreclosure. Yes, even this guy could get a new loan.

How is this possible? First, it is primarily based upon the equity in the home. The rule of thumb for these sub-prime loans is the greater the equity in the property, the weaker the credit can be. Conversely, the less equity, the better the credit must be. As an example...an A borrower who has been 30 days late on a mortgage and also 30 days late on minor credit card debt could qualify for a loan of up to 90% of the value of the house.

A D borrower, on the other hand, who is currently in foreclosure, could save his house if the equity is 40%.

Let’s look at an additional example...we have a couple who had an interruption in employment last year, and fell behind on a few items. The car fell behind by three months, the mortgage fell behind by two months, and a couple of the credit cards were as much as 90 days late. In all likelihood, you would be rated a B credit, and would be eligible for a loan of up to 85% of the value of the property. This would be for either a purchase or a refinance transaction. Currently, interest rates for a B credit grade loan range from the 8% level on an adjustable mortgage, to approximately 10.5% on a fixed rate loan. Granted, these rates are not as low as those for a prime borrower, but they are reasonable for the above credit history.

Another thing to think about.....when did your credit problems occurred. For most Sub-Prime lenders, the main concern is for the last 12 months. If your problems are over one year, it is very likely that the negative credit will not be counted against you. Some lenders review credit history for two years, so it is important to check with the lender on your particular loan. In any event there is probably a loan out there for you.

A decade ago, when borrowers had credit problems, they often had to resort to borrowing money from private parties or hard money lenders; the secondary market only purchased prime loans. Today, sub-prime loans are sold into the secondary market, in the same manner as prime loans.

Needless to say, there are literally thousands of scenarios for credit problems and many legitimate reasons why people have had their problems. Today, past credit problems does not necessarily prevent people from buying a home or refinancing the one they are in.

Money is plentiful, and I have many lenders with programs designed to help get people back on their feet, financially speaking.

Talk to Bruce Specter about this and other alternative credit programs. 

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This page was last updated on 02/14/08.