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Understanding Your Credit Score

Whether you are looking for a home in Kalamazoo, Plainwell, Allegan or anywhere in Michigan - the number one thing you need to be aware of is your credit score and how it can affect you in obtaining a loan for your new home.

For many years, the general public only associated the concept of credit scoring with the need to purchase high-ticket items such as a new car or home.  Today, credit scoring goes much further.  Your score can affect your ability to get a good rate on things such as car insurance, cell phones, or even determine whether or not you get the job you always wanted.  Credit scores have become a gauge for many employers, especially those that seek to place employees in a position of financial responsibility.

Why Your Credit Score is So Important

A credit score seeks to qualify the likelihood of a consumer to pay off the debt without being more than 90 days late at any given time in the future.  Scores can range anywhere between 300 - 900.  Most consumers range between 400 and 800.  The higher the score, the better it is for the consumer, because this will translate into a lower interest rate.  This in turn can save you thousands of dollars in financing fees over the lifetime of the loan.  One out of every eight prospective home buyers is faced iwth the possiblity that they may not qualify for the home loan they want because they have a score falling between 500 and 600.

The Five Factors of Credit Scoring

Credit scores are compromised of five factors.  Points are awarded for each component, and a high score is most favorable.  These are the factors in order of importance

1. PAYMENT HISTORY - 35% IMPACT   Paying debt on time and in full has the greatest positive impact on your credit score.  Late payments, judgments and charge-offs all have a negative impact.  Missing a high payment will have a more severe impact than missing a low payment, and delinquencies that have occurred in the last two years carry more weight than older items.
2. OUTSTANDING CREDIT BALANCES - 30% IMPACT   This factor marks the ration between the outstanding balance and available credit.  Ideally, the consumer should make an effort to keep balances as close to zero as possible, and at least 10% below the available credit limits.  (A balance 30% below the available credit limit is better.)
3. CREDIT HISTORY - 15% IMPACT  This portion of the credit score indicates the length of time since a particular credit line was established.  A seasoned borrower will always be stronger in this area.
4. TYPE OF CREDIT - 10% IMPACT  A mix of auto loans, credit cards and mortgages is more positive than a concentration of debt from credit cards only.
5. INQUIRIES - 10% IMPACT   This percentage of the credit score quantifies the number of inquiries made on a consumer's credit within a six month period.  Each hard inquiry can cost from 2 - 25 points on a credit score, but the maximum number of inquiries that will reduce the score is 10.  In other words, 11 or more inquiries within a six month period will have no further impact on th borrower's credit score.  Note that if you run a credit report on yourself, it will have no effect on your score. 

A credit score is just a computerized calculation.  Personal factors are not taken into consideration.  It is merely a snapshot of today's credit profile for any given borrower, and it can fluctuate dramatically within the course of a week.

How Does a Low Credit Score Affect My Interest Rate?

Lenders estimate your ability to pay back money based on your credit score.  The risk factor they take on is built -in to your interest rate as a financing fee.  Therefore, a low credit score results in a higher interest rate, higher monthly fees, and a higher amount of interest being paid over the total life of the loan.

Probably a borrower with a credit score of 620 would be questionable to an underwriter.  While the lender may agree to provide financing, the increased interest rate is factgored into the monthly payment.  The following chart illustrates the difference in the amount of interest paid over the life of the loan with three different credit score scenarios.

A borrower who increases his or her credit score from 620  to 720+ can potentially save $601 per month on mortgage payments, $7,214 per year, and approximately $216,432 over the life of the 30-year loan.

How Does the Underwriter View My Score?

If you are considering a home purchase, it is in your best interest to make very effort to increase your credit score, especially if you know you have issues you should be dealing with.  It is often the case that people are not aware of bad marks on their credit record until they apply for a major purchase such as a home.

As part of the loan process, a credit report will be run for you.  But you can also get a free credit report from each of the main CRAs:  Equifax, Experian and Transunion.  You can get the free report at the same time so you are aware of what information each agency has collected or just do one and then save the others for a later time when your rating has improved.

The underwriter who is making the decision as to whether or not you should get the loan you are asking for will generally look at the scores generated from all three CRAs.  Typically, the score willnot be the same from all 3 reports, and the underwriter will consider the middle score as a barometer.      

 Disputing Errors On the Credit Report

If you are in the process of reviewing your credit report, the first thing to do is make sure that the information in it is correct.  It has previously been found that up to 25% of total reports contained errors serious enough to result in the denial of credit.

If you find that you have errors on your report, follow this procedure to correct those errors.

1. Make a copy of the report and circle the items you are questioning.  Keep your original copy for your records.
2. Prepare a letter to the CRA that provided you with the report in question, and request to have the erroneous item(s) removed.  If you have proof of payment for an item in question, include a copy of that documentation.
3. Prepare a letter to the creditor reporting the problem, especially if you feel you are a victim of fraud or identity theft.  Inform the creditor that you are disputing an error reported to the CRA, state why the claim is inaccurate, and include any relevant documentation to prove your point.
4. Send your correspondence via certified mail.

You should receive a response from the CRA within 30-45 days.  If the error has been corrected, they will send you a fresh copy of your credit report at no charge to show you that the item has been removed.  They will also send a corrected report to any entity that received a report that contained the errors within the last 6 months.

If you can not have a disputed item removed, you have the right to include your side of the story on the credit report.  Be concise and to the point.

What if I Have No Credit?

On occasion, a borrower will not have enough credit references to obtain the loan they wish to secure.  If this is the case for you, start by opening small lines of credit that report to one of the 3 major CRAs, and make purchases that can easily be paid off.  If you do not already have a checking of savings account, open one.  You can then establish a history as a customer.

Ask your family or spouse to add you to their credit card account.  By adding your name to an established line of credit, you can ride on their coattails, so to speak, and gain points by using that person's credit history.

It is very wise to start saving money for the down payment on your home.  The lender will look at your application more favorabley when you are able to come to the table with a 20% down payment.  Bear in mind, there are certain loan programs available that permit a percentage of gift money for down payment, which can come from a relative, or even the person selling the home. 

Do's and Don't During the Loan Process

When you fill out a credit application, a report is sent to the underwriter.  Each lender and each loan program has different guidelines they must follow.  You should not do anything that will have an adverse affect on your credit score while your loan is in process. I know it is tempting...If you're moving into a new home, you might be thinking about purchasing new appliances or furniture, but this is really not the right time to go shopping with your credit cards.  You'll want to remain in a stable position until the loan closes and give yourself the opportunity to lock in the best rate possible.

Here is a list of do's and don'ts that you should adhere to after your loan application has been submitted to the lender.

Don't Apply For New Credit Of Any Kind - If you receive invitations to apply for new lines of credit, don't respond.  If you do, that company will pull your credit report and this will have an adverse effect on your credit score. 

Don't Pay Off Collections Or Charge-Offs - Once your loan application has been submitted, don't pay off collections unless the lender specifically asks you to in order to secure the loan.  Generally, paying off old collections causes a drop in the credit score.  The lender is only looking at the last two years of activity.

Don't Close Credit Card Accounts - If you close a credit card account, it can affect your ratio of debt to available credit which has a 30% impact on your credit score.  If you really want to close an account, do it after you close your mortgage loan.

Don't Max Out Or Over Charge Existing Credit Cards - Running up your credit cards is the fastest way to bring your score down, and it could drop up to 100 points overnight.  Once you are engaged in the loan process, try to keep your credit cards below 30% of the available credit limit.

Don't Consolidate Debt To One Or Two Cards - Once again, you will end up changing your ratio of debt to available credit.  Likewise, you want to keep beneficial credit history on the books.

Don't Raise Red Flags To The Underwriter - Don't co-sign on another person's loan, or change your name and address.  The less activity that occurs while your loan is in process, the better it is for you.

Do Join A Credit Watch Program - Your bank, credit union or credit card company may be able to provide you with a free credit watch program that can alert you to any changes in your credit report.  This can be a safeguard to help you intervene before the underwriter sees a problem.

Do Stay Current On Existing Accounts - Late payments on your existing mortgage, car payment, or anything else that can be reported to a CRA can cost you dearly.  One 30-day late payment can cost anywhere from 30 to 75 points on your credit score.

Do Continue To Use Your Credit As You Normally Would - Red flags are easily raised within the scoring system.  If it appears you are diverting from your normal spending patterns, it could cause your score to go down.  For example, if you've had a monthly service for internet access billed to the same credit card for the past three years, there's really no reason to drop it now.  Again, make your changes after the loan funds.

Do Call Your Loan Consultant - If you receive notification from a collection agency or creditor that could potentially have an adverse affect on your credit score, call your consultant to they can try to direct you to the right resources and prevent any derogatory reporting to credit bureaus.