Credit
Scores:
Credit Scores:
What They Are and Their Increasing Importance to Lenders
If you have been in the market for a mortgage loan
recently, whether to purchase, refinance or obtain
a home equity line, you have most likely heard a new
term in the mortgage industry lingo: credit score.
What is a credit score? And why is knowing about credit
scoring important to you?
Q. What is a credit score?
A. A credit score is a number, ranging
from the high 300ís to the mid-800ís,
which is developed from information contained in your
electronic credit files maintained by the three private
credit repositories: Equifax, Trans Union, and Experian
(formerly TRW). It is commonly referred to as a "FICO"
score, because the scoring model widely used by lenders
was developed by the Fair, Isaac & Co. Your credit
score represents your credit risk ñ how likely
you are to repay a loan.
Q. How is my credit score derived?
A. All of the information in your
credit file is analyzed. Your score is then calculated,
based on many factors, some of which are:
your credit payment history (have you been late with
payments? frequently? recently?); mortgage rates have
a more serious affect on your score
how you utilize your available credit (have you maxed
out your credit cards?)
the number of recent
credit inquiries (are you incurring more debt?)
the types of credit you use (do you have a lot of
finance company accounts?)
legal items filed against you (judgments, liens, bankruptcy,
foreclosure)
length of credit history
The scoring model considers each of these variables,
weighs each factor according to a formula, and then
ultimately yields a single composite score. According
to Fair, Isaac & Co., the two most heavily weighted
factors are past payment history and credit utilization.
The factors of age, race, gender, religion, national
origin, marital status, employment, income and where
you live are not evaluated. Although Fair, Isaac &
Co. provide data to support the validity of their
scores, scoring models are proprietary and they do
not publicly release information about exactly how
the formulas work.
Q. Is credit scoring new?
A. Credit scoring has actually been
around since the mid-1950ís, used for approving
credit cards and auto loans. However, it is only in
the past three years that credit scoring has been
used by mortgage lenders, so most consumers are not
aware of it.
Q. Why are mortgage lenders using credit scores?
A. Mortgage lenders believe that
credit scoring accurately assesses credit risk and
predicts loan performance: higher scores represent
a greater likelihood of repayment and lower scores
represent a greater risk of delinquency. This belief
is substantiated by an analysis performed in 1996
by economists at the Federal Reserve Board of the
correlation between credit scores and loan performance.
Additionally, investors who purchase mortgage loans
have also endorsed the use of credit scoring: they
now price loans (determine the interest rate) based,
in part, on credit scores. Since the three private
credit repositories (Equifax, Trans Union
and Experian) each have their own credit scoring model,
and consequently give their own individual credit
score to your credit file, lenders typically use the
middle of the three scores when underwriting your
loan.
Q. What is a "good" credit score?
A. Credit scores are broken down
into three ranges: a score of 680 and above is considered
a low-risk borrower; a score of 620-680 is considered
medium-risk; and a score of less than 620 is considered
high-risk. In the medium-risk range, other factors,
such as loan-to-value and debt ratios, are taken seriously
into consideration by the mortgage underwriter. So,
if a person has a 625 credit score, but has low loan-to-value
and debt ratios, he/she is looked at more favorably.
Q. Why should I care about having a high credit
score?
A. The primary reason is that your credit score is
a major factor in determining the interest rate you
will pay for your loan. Borrowers with low credit
scores (high-risk) are given higher interest rates
than borrowers with high credit scores (low-risk).
Almost every lender now uses credit scoring as a factor
in pricing loans.
Q. How do I find out what my credit score
is?
A. You can use a service like www.CreditReporting.com
that can give you a 3 in 1 Credit Report or contact
each of the three private credit repositories for
a copy of your credit file, which includes their individual
credit score: Equifax @ 800-685-1111; Trans Union
@ 800-916-8800; Experian @ 800-682-7654. Or call Pam
Stair at The Mortgage Group at 925-838-4871.
Q. How can I improve my credit score?
A. First, and foremost, review your
credit file from each of the three private credit
repositories for accuracy, and begin immediately to
correct errors. Then, according to Fair, Isaac &
Co., the three key things to remember are to pay your
bills on time, keep credit card balances low, and
apply for new credit sparingly. All of these things
will make you a good credit risk and produce a high
credit score.
Q. Why is credit scoring so controversial?
A. One reason is that credit scores
are calculated on the raw data found in your electronic
credit file, which is not always accurate. And correcting
inaccurate information can take a lot of time. The
scores also do not take into consideration such variables
as a recent illness, job loss or the like, which can
temporarily affect credit. For these reasons, as well
as several others, many feel that credit scoring should
be approached cautiously and not be given too much
weight in the final decision of whether to grant a
mortgage loan. However, the use of credit scoring
as an evaluative tool is increasing dramatically in
the mortgage lending industry, so consumers need to
be aware of it and how it is used.
