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Giving Credit Where Credit Is Due
Kevin J. Daum
This article was originally published in a 2007
edition of Log Homes Illustrated magazine.
It was only a few years ago when assessing credit was a subjective art practiced among bankers and credit officers. They would peruse over your credit report arbitrarily deciding based upon all of your accounts and payment history whether or not you were a risk worth taking. Today like in everything else, technology has crept into the mix. In the last ten years the majority of the consumer finance and mortgage industries have moved to using credit scores (also commonly referred to as FICO scores) in determining whether or not you qualify for a loan. These scores can be very beneficial or detrimental in assisting you with acquiring financing. Mostly they have remained a mystery to the public even though they have tremendous impact on qualification.
Originally used by car finance companies and credit card companies, today almost all lenders use credit scoring for underwriting loans and making credit decisions. Lenders run reports from the three major bureaus in the United States that report credit: Experian (formerly TRW), TransUnion, and Equifax. These companies all use a computer modeling system to assess your credit and predict how you’ll perform on your loan. The Fair Isaacs Company created the system for Experian, hence the reason credit scores are commonly referred to as a FICO score (the other bureaus have their own brand names for credit scores, including Beacon and Empirica).
Behind the scenes in the lending world, underwriters look at the three scores reported by the bureaus for both you and your spouse. The underwriters take the middle score of the three bureaus for each of you and use the lower of the two scores to determine your creditworthiness. This means your credit file is only as strong as the 2nd to the weakest of all of the combined scores. Often it can be to your advantage to remove one of you from the application if the scores are too low. Of course there are other qualification aspects such as income and assets to be considered at that point.
Credit scores are heavily impacted by three issues in order of importance:
Derogatory (bad) credit. Late mortgage payments within the last 12 months do the most damage, with late payments on car or student loans also doing major damage. Late payments on revolving debt (credit cards or store accounts) can impact you if less than 12 months have gone by or they are frequent. Collection accounts, tax liens, bankruptcies, and foreclosures are problematic if less than 2 – 3 years have passed.
Credit-card balances. The best scores go to individuals who use credit wisely, and who keep their credit-card balances under control. Ideally, you need to have several established accounts with the balances equaling no more than 35 percent of the available credit limits. Maxing out your cards can drop your scores 20 to 50 points, so try and avoid extending your balances beyond the 30 day grace period.
Inquiries - Whenever you apply for credit — for a car loan, a credit card, or even to rent an apartment — your prospective lender makes an inquiry to check your credit report. This inquiry has an impact on your credit scores. The more inquiries you have, the more you smell like someone in financial trouble to the computers. Keep your new credit inquiries to a minimum. You can shop an unlimited number of mortgage companies within a 30-day period without impact to the score. Beware of over using Internet credit-checking services because they also generate unwanted inquiries. Inquiries older than 90 days have less impact on the score.
The credit scores range from 400 to 900 and lenders will set their lending criterion based upon ranges in the scores. Each lender sets their range independently but there are some trends. Here is a typical breakdown of score categories.
720 and Above This is considered excellent or perfect credit. This score qualifies you for just about any program offered today with most lenders. If your score is this high then nothing else in your credit would be problematic. I often have high achieving clients in this range that want to improve their score as if it was their SAT test score.
680-719 This is considered good credit. With few exceptions, most programs from most lenders can be had with this score, including no-income-qualifying (NIQ) loans. And high Loan–To-Value (LTV) loans where you can put little or no down payment on a property. Most often the score has been lowered due to a late payment or moderately high credit card balances.
620-679 This is considered fair credit. This score limits your choice of lenders and programs. Many NIQ programs require scores higher than 680 and 640 for full documentation. It’s likely that this borrower has a few late payments and possible some collection accounts or public records. He may also be tapped out on his credit cards.
500-619 This category is referred to as Subprime credit and sometimes referred to as B-D paper. There are institutional lenders who specialize in programs for people with this credit. The rates and fees are higher and the LTVs are usually lower. Often the programs are designed to be short term loans with prepayment penalties. Borrowers with theses scores can often have tax liens, bankruptcies, judgments or just lots of late payments and credit card debt. If you are in this position time is your best friend. Subprime loans can buy you some of that time until you can clear the problems and refinance.
499 and BelowOften referred to as Bad credit the only sources for loans in this category are usually private or “Hard Money” lenders. These lenders are unconcerned about the credit because they are lending strictly upon the value of the property often with a lower LTV to reduce there risk. Scores this low usually reflect open bankruptcies, judgments, foreclosures, collections and probably maxed out credit cards. Time is your only friend in this category and the clock for credit repair won’t start until the open problem accounts are closed in some manner.
To fix a credit score, you have to focus on those items that are negatively affecting your credit score. The credit report will list in order of importance which items are having the most impact. The report will also list every creditor on the report. If information is wrong and you can get a letter proving it, you can submit the letter to the bureau and it should reflect in roughly 90 days. Because of the increased weight of credit scoring in underwriting, several credit reporting agencies have moved to a process called “Rapid Re-scores.” This method can effect change in your report in as fast as a few days.
To get a rapid re-score you must first find a credit agency that has the capability to do them. A good loan officer should be able to help. Let’s say for example that the balance on your credit cards is too high in proportion to your credit limit. You could pay down the balance on your credit card by 50 percent and then request a letter from the credit card company (must be on official company letterhead) that confirms your balance reduction. Then, you submit a copy of the letter to the credit agency in order to get a re-score. Note that only 2 of the 3 reporting bureaus will change the score based upon balance reduction. Once the agency re-scores, your credit score will improve.
Be careful when you pay off certain types of debts such as collection accounts or outstanding tax liens. Any recent activity on a derogatory account reflects negatively in the credit scoring. As an example, let’s say you have a collection account from two years ago that is unpaid and you pay it off now. Unfortunately that action will cause it to show payment activity in the last year which can drop your credit score significantly. It is best to have a professional assist you in choosing what to pay off. Make sure your Loan Officer truly knows this system or you could find yourself in danger of being denied a mortgage for up to a year.
If Rapid Re-scoring isn’t an option due to serious delinquencies like recent bankruptcy or foreclosure, no need to panic. Life is not over as you know it. Time heals all wounds! Everything negative drops off your report in 7 to 10 years. You may think that seems like a long time, but as time passes most issues older than two years — even foreclosures and bankruptcies —have less impact on your credit score. It is important to re-establish credit by opening new accounts and keeping up the old with timely payments and low balances.
The best way to keep your credit score high is to make payments on time and keep your credit card balances low. Installment loans for cars and houses help your credit so don’t be shy about financing big ticket items like that log home you have been dreaming about. As long as you pay attention and are diligent in managing your finances you are sure to get the credit you deserve.
Kevin Daum is the Founder and CEO of Stratford Financial
Services, a Real Estate finance and education company, founded
in 1989. Stratford specializes in Purchase loans, Refinance
loans and Custom Home Construction finance and has successfully
financed thousands of clients. He is the author of "Building
Your Own Home for Dummies" (Wiley), as well as "What
the Banks Won’t Tell You." Mr. Daum was an Underwriter
for Plaza Savings and Loan and Key Bank of New York. He is
an INC 500 CEO and has been listed as one the 40 Most Influential
People Under 40 in the San Francisco Bay Area. He is the Global
Chair for the Edison Innovation Program with the Young Entrepreneurs'
Organization (YEO) and is a founding Board member of the Bay
Area Chapter of YEO.
Mr. Daum is a frequent contributor to numerous business
publications on the subjects of Real Estate and Small Business
leadership and speaks regularly on both subjects. He can be
contacted at kevin@stratfordfinancial.com.
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