What is a Fico Score?
Historically, mortgage interest rates have varied by loan-to-loan value and by term only. On "A" borrower mortgages, variation in credit risks were not generally taken into consideration. Any variance in interest rates was primarily due to the additional charge for mortgage insurance (PMI) on home loans with loan-to-values greater than 80%, or higher rates due to the length of amortization (30 years vs. 15 years). The exception to this trend is sub-prime loans.
Sub-prime lenders are lenders who specialize in providing loans to borrowers who cannot qualify for traditional financing due to credit impairment or difficult to verify income. These lenders have used "risk-based" pricing for years. The greater the risk, the higher your interest rate will be.
A leading credit indicator used by lenders to determine risk-based pricing is the FICO (Fair Isaac Company) Score. Mortgage lenders use FICO Scoring to speed up the loan application process by simplifying credit review. Recently, in the last two years, Fannie Mae and Freddie Mac have also incorporated FICO Scoring into their credit documentation requirements on prime mortgage loans.
DEFINITION:
FICO Scoring is a formula for credit risk assessment that is believed to be highly predictive of future payment risk.
The borrower's score is derived by weighing credit information at a snapshot in time and assessing "points" for each piece of information. The information is taken from a credit bureau file and scores are based on credit information only. By law, an applicant's credit worthiness cannot be judged on your race, religion, marital status, gender or nationality. According to Fair Isaac, the information is, therefore, objective, consistent and does not discriminate.
FICO Scores can fluctuate, however. Depending on the credit repository the information is taken from and the geographical location of the borrower, there may be more or less information available, which leads to variations in scoring.
CALCULATION:
The borrower's score is calculated based on assigned numerical values for certain credit characteristics. The higher the overall score, the less risk there is for the lender.
Higher risk characteristics are...
· Bankruptcy
· Non-bankruptcy derogatory public record
· Charge-offs or loan defaults
· Repossessions
· Serious delinquency
Additional characteristics that determine credit score are.
· Number and age of trade lines
· Presence of derogatory trade line information
· Current level of indebtedness
· Types of credit available (revolving vs. installment)
· Amount of time credit has been in use
· Credit inquiries
WEIGHT:
Credit usage is the key factor. Each characteristic is weighed according to its "predictive power." Those factors with the highest weights are collections, judgments, bankruptcies, late payments, current balances, too few or too many revolving accounts, finance company accounts, number of accounts opened in the past 12 months, collections and number of credit inquiries made.
FICO Scoring looks at credit patterns over a period of time. In other words, one late payment will not ruin your credit score. However, a history of late payments and high credit balances will have a serious effect on an individual's score.
ERRORS:
Errors on credit reports occur for many reasons. In the case of a divorce, your buyer's credit may be impacted if their spouse does not maintain payments, even if the court made their spouse responsible for the outstanding debt. If your buyer has a bankruptcy that was discharged there may be outstanding charge-offs or unpaid collections on the report that in fact were discharged through the bankruptcy. Encourage your buyers to check their credit reports at least once a year.
If your buyer feels there are any errors contained in their credit report, they should contact the credit bureau. According to the Fair Credit Reporting Act, borrowers may fill out credit dispute forms and file them with the credit bureau for investigation.
They may do so by contacting the appropriate credit repository, the 3 repositories are listed below:
· Equifax · (800) 685-1111 http://www.equifax.com
· Experian (TRW) · (888) 397-3742 http://www.experian.com
· Trans Union Corp · (800) 916-8800 http://www.tuc.com
COUNSEL YOUR BUYERS:
Counsel your buyers before they go house hunting. New debt, particularly for major expenditures, has an immediate negative impact on your buyer's score. Bills need to be paid on time, all the time. Delinquent payments and collections will have less effect on their score over time. Borrowers need to pay down balances on open trades. Be aware that revolving debt has higher negative impact on a borrower's score than installment debt. "Shopping" for credit and opening new credit card accounts to pay off old accounts will influence scores. Minor difference in FICO Scores can increase the interest rate significantly, as well as increase the documentation required by the lender to obtain a loan.
Credit scoring has assisted lenders in identifying the risk factor in financing a home for borrowers with credit challenges. A wide variety of home loan products are available to those buyers through alternative lenders.
Borrowers with low credit scores are now, more than ever before, able to purchase or refinance homes. Don't make the mistake of walking away from a good buyer who cannot qualify through a traditional lender.
For more information - Please call Paul Miller - Realtor @ 619-497-3415
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