Your credit score, although an imperfect representation, is the tool lenders use to assess a borrower’s trustworthiness. The score calculated and reported by the reporting agencies we’ve all heard of, such as Experian, Equifax, and Transunion. As we know, the score they report plays a major factor in your ability to obtain a home loan.
Scores usually range between 300 and 850; the higher the score the better (obviously). When applying for a mortgage a lot will depend on where you land on this scale. As of now, this is the basic breakdown of the different tiers your credit score can fall into when applying for a mortgage.
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Above 740 – Best
A 740 and above is the gold standard for a mortgage applicant. Lenders want you, and borrowers want to be you. You will credit qualify for premium pricing on all Conventional Loans.
720-739 – Great
In this range, you are still doing quite well. However, there will, in most cases, be a small loan level price adjustment (extra charge due to added risk) of 0.25% of your loan amount assessed on Conventional Loans. This charge will be included in your closing costs.
700-719 – Good
As long as other factors (LTV, loan amount, DTI) align, conventional loans are generally still cheaper than FHA products in this range. Borrowers will be assessed a price adjustment of 0.75% of their loan amount on Conventional Loans.
660-699 – Okay
In this range, you will likely still qualify for a Conventional Loan; though, the loan level price adjustments usually make Conventional options more expensive than FHA loans at this point.
620-659 – Qualifying
620 is widely seen as the barrier to entry in the mortgage industry. After surpassing 620 (excluding other factors) eligible veterans can qualify for VA loans, while all other borrowers may qualify for FHA programs.
580-619 – Difficult to Qualify
Though there is an FHA loan program for borrowers between 580 and 619, the additional guidelines are so specific and restrictive that it is often not worth applying at this stage. The fallout rate for 580-619 borrowers is considerably higher than other mortgage programs.
Below 580 – Poor
Currently, borrowers with scores below 580 will not qualify for traditional residential mortgage products in the US.
What most people don’t know is there’s a list of standards that can cause your credit score to move up or down and not all are straightforward. According to FICO (MyFICO.com), there are five criteria that are taken into account and are each weighted differently.
Comprising 35% of your overall score, credit history is the most important aspect of your credit score. This is your track record; any derogatory marks, late payments, bankruptcies, foreclosures, etc. fall under this category.
Credit utilization refers to the running balances on your credit cards as well as other ‘revolving’ debts (lines of credit, HELOC, etc.). Every credit card and/or line of credit places a cap on the amount one can potentially borrow called the ‘maximum.’ By totaling the maximums on your revolving accounts and comparing it to the sum of your outstanding balances, the agencies determine your utilization percentage. The closer your total balances are to your overall maximum, the lower your score will be.
Although seemingly trivial, the credit reporting agencies factor in the average age of your open accounts. Imagine, two borrowers with the same immaculate track record, only one has maintained that track record over a longer period of time. It makes sense that this borrower would have a higher score, correct? For this reason, the age of your credit is a consideration.
Imagine again, two borrowers with similar outstanding track records; however, one borrower maintains only one open credit card account, while the other is successfully managing a car note, mortgage, student loans, and a credit card, all at once. Clearly, the latter has demonstrated a better performance history, though this is a lesser consideration in your overall score.
Inquiries/ New Accounts (10%)
Many borrowers will open new credit accounts as they see fit, moving balances from one “interest-free” credit card to another, consolidating debts with personal loans, and taking advantage of special benefits and signing bonuses wherever they’re offered.
Now, I’m all for gaming the system and these tactics can be a savvy way to manage credit. However, there is a small price to pay for every such action. Not only do credit inquiries have a minor effect on your score (even if you do not open an account), but adding new accounts will also decrease the average age of your credit (see #3).
On Credit Repair Agencies…
Although I wish I all one needed to do to fix their credit is to simply call a credit repair firm, pay them a little money, and watch as your derogatory accounts evaporate into thin air, unfortunately, this is not how it works. Head the wise words you’ve heard time and again: if something seems too good to be true, it usually is.
If you choose this route, and depending on your situation, your score will often increase, sometimes by a lot. What’s less obvious, however, is the reason why your score has increased. As a way of resolving mistakes on your credit report, reporting agencies allow you to dispute derogatory accounts, temporarily removing that account from their calculation, thus artificially boosting your score.
This is what credit repair companies do on your behalf (something you can do on your own for free). On rare occasion, if you present evidence that the accounts are inaccurate, they may not have sufficient legal standing to remain on your credit report, and, therefore, the increase will be permanent. Most of the time though, this will not be the case.
After the reporting agency resolves the dispute seeing that the derogatory mark is legitimate, the account will once again be calculated into your score yielding no change besides a lighter pocketbook on your end.
The obvious question here is: will I be able to qualify for a mortgage in the meantime, while the accounts are being disputed?
The answer is almost certainly no. Lenders are abundantly aware of this deceptive practice, and therefore place a cap on the number of allowable disputed accounts. That means that although your score is high enough to qualify, your application will be rejected for having too many unresolved disputes.
Yes, I hate to be the bearer of bad news, but there is no panacea for credit issues. Every credit problem has their respective guidelines and effective methods for remedying the situation.
Common Credit Issues:
No Credit/ Lack of Credit
This is an unfortunate problem that many people don’t realize they have until it’s too late. Although it can’t be remedied with a snap of a finger, it is much easier to build credit than to rebuild credit.
When trying to build credit for the first time, many people run into what I call the Credit Catch 22. That is: it takes credit to build credit. If you don’t have credit, how can you get approved to open an account and begin building credit?
Secured credit card. As opposed to regular credit cards, secured credit cards borrow against your own money, making approval a virtual guarantee. Essentially you set up an account, deposit $1000 for example, and now you have a credit card that allows you to borrow up to $1000.
A secured credit card is similar to a debit card, only the amount in the account won’t decrease when you make purchases, instead, you’ll pay interest on any balances you carry over a month (so don’t carry balances). Your track record will then appear on your credit report, building your credit slowly but surely.
This is one of the easiest credit issues to fall prey to. The temptations we face on a daily basis to live outside of our means are neverending. With credit cards so readily available it is easy for everyday purchases to add up, ending in a painful debt hangover. Lucky for us, there are multiple ways to remedy the situation
Remedy #1: Consolidate
You can consolidate credit card debt in a number of ways. One way is to use a personal loan. Personal loans may not have the lowest interest rates, but they are generally much lower than credit cards. Thus, not only will a personal loan save you money in the long term, but also, since loans are not considered ‘revloving’ debt, your utilization will decrease while adding to your credit variety at the same time.
The drawback here is opening the new account has a deleterious effect on the average age of your credit. Not to mention, a personal loan will usually carry a higher minimum monthly payment, causing your debt-to-income ratio (DTI) to increase.
You might also consider transferring your balances to an interest-free credit card. Like the personal loan, approval is not always guaranteed; however, if you are approved you can get up to 18 months interest-free on some cards. This will not only eliminate your interest payments and lower your DTI, but it may also raise your maximum without raising your balances; therefore your utilization will decrease. Once again, however, adding an account has its drawbacks.
Remedy #2: Paydown/ Payoff
I hate to state the obvious but one of the best ways to increase your credit score is to just simply pay your credit cards. It will take diligence and will be undoubtedly painful, but in the long term, you will have eliminated interest payments, lowered your utilization, increased your credit score, lowered your DTI, and saved your future self considerable stress.
If you can’t pay them off, consider paying them down. Utilization is measured in tiers, and although the reporting agencies do not reveal the exact calculations, the lower your balances compared to their max, the better off you’ll be.
Pro-tip: If possible, payoff or consolidate debts 1-2 months before applying for a mortgage. This will allow the effect of the action to show on your credit report before you apply. Furthermore, Conventional Loans (securitized by Fannie & Freddie) cost more and are more restrictive, the lower your credit score; therefore, paying off credit cards beforehand can equate to thousands of dollars in savings both at closing and over the life of the loan.
Recent Foreclosure, Bankruptcy, Short sale
The Great Recession is still recent in memory, and its scars are lasting. Even those with the best of intentions have fallen victim to the rare unexpected events that life presents, and all such victims must bear the consequences. Fortunately, none of these events automatically disqualify you from obtaining financing.
Though a foreclosure, the cardinal sin of credit offenses, will eliminate you from obtaining a Conventional Mortgage (Fannie Mae/ Freddie Mac) for 7 years, FHA allows borrowers to seek financing after only 4 years.
For bankruptcies and short sales, some cases require no exclusion period whatsoever. See Fannie Mae Guidelines.
The best remedy for major credit events like foreclosure, bankruptcy, and short sales is time. Given sufficient time not only will the exclusion period lapse but the event will also lose its effect on your overall score, after ten years or so dropping off the report entirely.
Pro-tip: When a major credit event is inevitable, such as an impending foreclosure, be sure not to drag matters out too long. The earlier the event is concluded or discharged, the earlier the exclusion periods will lapse and the earlier credit scores will rebound.
Remember that exceptionally chaotic month when you were juggling far too many things at once and was topped off with an alert from your credit card company informing you that you missed a payment? Though it is a rude awakening and late fees are not fun, this sort of infraction will not show in your credit report. Credit reporting agencies only report late payments if they are over 30 days past due, compounding their effect if they surpass 60 or 90 days. These are serious infractions that affect the ‘history’ portion of your credit (comprising 35%). In addition to having a lasting deleterious effect on your score, Lender’s also place limits on the number of late payments that are allowed before knocking you out of contention for a mortgage.
Unfortunately, late payments are similar to major credit events. Unless you can take successful legal action against the validity of the accounts, time is the only cure. The longer it has been since the accounts have been brought current, the higher your scores will be. It is worth noting, once again, that late payments do not automatically disqualify you as a borrower, so be sure to talk to a loan officer to determine where you stand.
This one is easy. If you don’t have legal standing for disputing a credit account, then you shouldn’t be disputing it. Simple as that.
Call credit reporting agencies and remove all disputes. If a credit repair agency is disputing them on your behalf, fire them. 99 times out of 100 these disputes are not helping you.
If by chance, you are truly questioning the validity of a derogatory account, then try to resolve the matter as quickly as possible, as the dispute itself will decrease your chances of qualifying.
The precise effect of credit inquiries on your overall score is not widely known, as the reporting agencies do not reveal their specific calculations; however, their effect is minimal if used in moderation.
The obvious question: Lenders have to check my credit when I apply for the mortgage right? What effect will that have?
Try not to worry about it too much. As long as you are not applying for credit all around town, the mortgage inquiry will have little to no effect. Furthermore, applying for a mortgage is a multi-step process and reporting agencies are aware of this fact. Thus, usually, only the first mortgage inquiry will be counted, as long as the other inquiries are within a month or so. This gives you the ability to shop around without destroying your credit.
Remember, in the end, your credit report is a tool. The sole reason to keep that tool sharp is to help with the important things. Your home, and its financing is certainly one of those things.
Conclusion: Focus on Utilization
Rarely, indeed very rarely, do these credit issues show up alone. Usually, credit issues are endemic of a greater problem: loss of employment, economic hardship, lack of awareness, and, yes, occasionally apathy. As such, there can be a windfall effect where one overlying cause can leave a litany of repercussions in its wake. If this is the case, the best thing to do is take things one step at a time.
Of course, bringing things current will be the first priority, but remember your track record is only 35% of your total score. Once things are brought current, the most effective action is usually to focus on utilization, bringing your credit card balances to below 10% or even 0% if possible. This will have the most immediate positive effect on your score and can not only improve your chances of qualifying but also significantly decrease the cost of your mortgage.
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