Understanding Credit

Perhaps the most important part of buying a home is knowing how much you can afford and how much you can get a loan for.  When applying for a loan you will be asked to provide:

  • Bank statements
  • Previous tax returns
  • Current pay stubs

In addition, your lender will pull a credit report which details your payment history with all of your creditors.  It is very important that you understand how your credit is scored and how it can be affected by your credit history.

YOUR CREDIT REPORT

It is always a good idea to review a copy of your credit report annually. By doing this, you can correct any errors on your credit profile in advance of a purchase, establish credit if necessary, or start repairing your credit if you have had problems in the past. Lenders look very carefully at your credit as an indicator of your willingness to repay your loan. Having poor credit, little or no established credit, or having unresolved disputes with creditors, can affect your purchasing power and your ability to get a loan.

The Fair Credit Reporting Act (FCRA) requires each of the nationwide consumer reporting companies — Equifax, Experian, and TransUnion — to provide you with a free copy of your credit report, at your request, once every 12 months.  To order, visit www.annualcreditreport.com, call 1-877-322-8228.

You can also request a copy of your credit report for a small fee by writing to any one of the following credit bureaus:

  1. Equifax – P.O.Box 740241, Atlanta, GA 30374 (800) 685-1111   http://www.equifax.com
  2. Experian – P.O.Box 949, Allen, TX 75013 (888) 397-3742   http://www.experian.com
  3. TransUnion – P.O. Box 390, Springfield, PA 19064 (800) 916-8800   http://www.tuc.com

When you receive your credit report, check for the following items:

  • Incorrect Entries: If there is a mistake on your credit report (i.e. accounts that are not yours or on-time payments that are showing as late), you can have them corrected by writing to each credit bureau and requesting that the information be deleted. They will contact the creditor who must respond within 30 days. If the creditor does not respond, the item will be removed and a new credit report will be issued to you. If there is still a dispute, you can add a 100-word statement to your file explaining your side of the story.
  • Outdated Negative Credit: If there are unfavorable credit items older than 7 years showing on your report, follow the procedure outlined above. Bankruptcies can be removed after 10 years.
  • Current Negative Credit: If you have current credit problems, the time to resolve them is before you buy. Re-establishing good credit after a bankruptcy or other credit problems is very important.

Having an established credit history is also important, as lenders want to see a track record of debts owed that have been repaid. If you haven’t already done so, apply for credit cards and use them, or establish credit history by documenting your monthly rent payments and your monthly payments to utility companies.

ANATOMY OF A CREDIT SCORE

Credit scores today are generated by a complex series of algorithms designed to assess the risk that a borrower will have a late payment within 24 months. Though every borrower is assessed by the same parameters to generate a credit score, these parameters are weighted differently depending on the borrowers’ characteristics and how well the borrower fi ts one of ten profiles. Specific profiles are reserved for individuals with even just one 90-day late payment or bankruptcy in their credit history. Mortgage lenders tie their rates directly to credit scores.

Components of the score

Though the model evaluates each data element with respect to “Recent-cy”, “Frequency” and “Severity,” the most important of these perspectives is recent-cy.

35% – Payment History – The perspective weighted most heavily in assessing payment history is recent-cy.

  • Age of last late payment < 7 months = big hits
  • Age of last late payment < 7-24 months = less hit
  • Age of last late payment < 24 months = significant relief

30% – Balances – This portion of the score assesses how wisely an individual utilizes their credit. Ideally a borrower should have between 3-5 credit lines. If the ratio of cumulative available revolving credit to cumulative current balance is high, the credit score will take a hit.

  • Ratio < 50% = no hit
  • Ratio > 50% but < 75% = less hit • Ratio > 75% = big hit

15% – Credit History – This portion of the score assesses the number of new trade lines and their respective ages. If trade lines need to be closed, careful consideration must be made to the effects of trade line age per credit amount extended.The most credit-scoring-wise decision would be based on the reason codes in the individual report making specific accommodation for individual circumstances.

10% – Type of Credit – This portion of the score reflects what the scoring engine determines a “good” mix of credit types.What is “good” in one profile type may not be as good if assessed according to another profile type.Across all profiles, however, finance company credit lines are negatively assessed.

10% – Inquiries – Because the engine assumes that a person applying for multiple trade lines within a short period of time may be indicative of financial trouble, this portion of the scoring engine examines the number of inquiries over time made to an individual’s credit report.

The scoring engine treats certain economic sectors differently than credit line issues. If an inquiry is made by a lender within the last 12 months, the mortgage financier gets a 30 day window during which time additional inquiries will not negatively affect the score.

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REBUILDING YOUR CREDIT

A poor credit rating can affect your purchasing power and your ability to get a home loan. There are many things you can do to restore your credit.

Make sure your credit file is accurate. Credit files are maintained by three credit reporting agencies—Experian,Trans Union and Equifax. You can contact one of them and request a copy of your credit report for a small fee. Review the report for errors and outdated information. If you feel that any of the reported information is inaccurate, you can request that the date be removed. The credit agency will contact the creditor who has 30 days to respond and confirm the disputed items. If they do not verify it, the date will be deleted. If the creditor verifies that the information is accurate, you can write a 100-word statement explaining your position and have the credit reporting agency include it in your credit file.

Contact your creditors – Some creditors will remove derogatory information from your credit file if you pay a full or partial payment towards the debt. They may also “re-age” the account by making the current month the first repayment month, thus showing no late payments. You can call the creditor directly to do this.

Add positive information to your file – Send information to the credit bureaus that shows stability and the ability to make payments on time. For any accounts on your credit report that do not show you pay on time, you can send account statements and copies of cancelled check to show your payment history, and the credit bureaus may add them to your history. If you have long-term employment, have lived in the same place for a length of time, etc., be sure to add documentation to your file that shows this stability.

Get credit in your own name – If you are married and your spouse has had financial problems, be sure that you establish credit in your name alone.

Re-establish good credit – If you have had credit problems in the past (especially a bankruptcy), it is important that you re-establish good credit. There are several ways to do this:

  • Get a secured credit card. Many banks will, in exchange for a sum of money deposited with them, give you a credit card. Use the card and make the payments on time. Your credit rating can quickly improve.
  • Obtain a secured loan. If you have a passbook savings account or can open one, ask the bank to give you a loan against that money. They keep your passbook until the loan is paid in full. Make sure the bank reports on the loan to the credit bureau.
  • Work with a local store. Some businesses will give you credit on a purchase regardless of your credit standing. Although you may pay a higher rate of interest, this in another way of re-establishing good credit.
  • Satisfy judgments, liens and collections. Make it a priority to satisfy any unpaid judgments, liens, and collections against you.

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THE IMPACT OF FORECLOSURES ON FICO® SCORES

The current trend in the marketplace is focused on the impact of foreclosures across the country.  This trend has resulted in various opinions on the types of foreclosures (Short Sale, Deed in Lieu and Foreclosure) and its impact on a borrower’s FICO® score.

This topic, which is raised in news articles and other industry collateral, has generated many questions among members of our various sales channels; mainly, how score models calculate each type of foreclosure.  After soliciting assistance from various individuals and resources—including each of the three major credit bureaus and CreditXpert —we have compiled the following information for your review.

While many people have associated a target point impact anywhere from 100 points on a Short Sale to 280 points on a foreclosure, Fair Isaac has told us that FICO® risk scores do not distinguish between the three types of foreclosures.  There are so many variables in a consumer’s credit report (do they have collections or other public records?) in addition to the foreclosure account that a point impact is almost impossible to gauge. Further complicating the score prediction is how the foreclosure account is reported, and if a public record accompanies it.

Each article we’ve seen suggests that a Short Sale has less of an impact on an applicant’s FICO® score than a Foreclosure, but downplays the fact that there could be legal action taken by the lender on the deficiency balance from a Short Sale.  If this is the case, there would then be both a derogatory trade line and a Public Record reporting.  This is the same result as a Foreclosure; a derogatory tradeline plus the Foreclosure Public Record. Even without the Public Record filing there would still be the reporting of an MOP 8 on the Short Sale tradeline.  This would have a negative impact on the applicant’s score equivalent to a foreclosure tradeline. Finally, Short Sales are typically facilitated to those applicants who have encountered credit issues.  These issues would be reflected in the derogatory reporting of other credit items within the consumer’s credit profile.