Posted on August 6, 2015 - 12:51 PM
by Natasha Hunter
Lenders look at credit history to get an idea of how buyers may handle future debt.
While a buyer's credit score can determine overall loan program eligibility, it's thereport entries that are more closely studied during qualifying and underwriting.
Today we'll discuss how lenders look at those specific entries during the loan approval process, since credit qualifying involves more than just the score number.
Along with Income and Assets, Credit is one of the 3 main factors that lenders consider when qualifying a buyer for a mortgage.
It's a major part of lenders' risk management, a topic we've
addressed a few times in earlier newsletters.
Take a look at this credit usage chart,
then we'll briefly discuss each category:
Remember that a person's spending and paying behavior are reflected in the credit reports compiled by the 3 major credit bureaus, then those report entries are analyzed and evaluated by FICO® proprietary scorecards to arrive at the score.
What's important to FICO® scoring models is also important to lenders - credit report entries are interpreted in much the same way by both.
Let's break down what goes into the credit reporting categories -
Payment History (35%)
This includes a person's payment record. Accounts are separated into installment (fixed payment period, like a mortgage or car loan) and revolving (open-ended such as credit card).
Creditor companies report payments as :
- current / paid as agreed (positive for score) - over 30, 60, or 90 days late (variable negatives) - settled for less than amount owed (significant negative) - charged off, sent to collection (serious negative)
Short sales, foreclosures, and deeds-in-lieu are reported as such and seriously impact a credit score. Credit report negatives are called derogatories and usually remain on a report for 7 years, affecting the score in decreasing amounts each of those years.
Mortgage derogatories are viewed as more negative than those for credit card accounts.
Lenders look at the number, dates, and types of
negative credit report entries, not just the score.
Payment patterns (positive or negative) are interpreted as a gauge of the borrower's willingness and commitment to repay a future loan.
Amounts Owed (30%) -
This category refers not only to the total amount of debt a person has, but also how much of his or her maximum limit is being used.
The more credit used out of the max amount available, the more it will reduce the score. Lenders like to see credit usage under 30% or so of the maximum limit. The lower, the better.
Important - credit reports and scores update monthly to reflect current spending and payment activity.
The more a borrower owes other creditors, there is potentially less monthly income left to pay the mortgage.
Length of Credit History (15%) -
This one is fairly self-explanatory. The longer a person has satisfactorily and responsibly used and managed a credit account, the better it looks to scoring models and lenders.
New Credit (10%) -
When a person applies for new credit, he or she is either
thinking about buying something that costs enough to need financing or wants to be able to spend more at some point in the near future.
It means that this person may be ready to take on more debt than previously carried.
Lenders like to know that borrowers have the ability to pay
both their existing commitments and any new bills.
Credit applied for during the last 6 months will show up on the credit report as new and will lower the score slightly. New accounts are referenced to credit inquiries that are shown on the report.
New lines of credit require a written explanation from the borrower when applying for a mortgage. The explanation includes why the person applied for new credit and whether or not a purchase was made with it. The pre-closing credit report followup will verify the explanation details.
Once any new debt has been handled with on-time payments for awhile, it becomes just another trade line for which the person is responsible.
Types of Credit (10%) -
As mentioned above, scoring models regard mortgages and car loans more seriously than credit card debt. Well-managed installment debt has a more positive bearing on a score than similarly well-managed revolving debt.
This has to do with mortgages and car loans having a specificpayment term/period by which all payments must be made, whilecredit card style debt is open-ended.
Installment debt also has a fixed, required amount which must be paid each month, while revolving accounts have a minimummonthly payment.
It's also interesting to note that scoring models (and lenders) regard bank-issued card payment history as more influential than store-issued card history. Visa® and MasterCard®accounts affect credit reports and scores more than Best Buy or Lowe's credit cards.
When buyers have credit issues to address,
it's much better to work on them before looking at homes or
applying for a mortgage.
Better credit reports and scores open up new opportunities
and options for homebuyers by allowing them to receive
more attractive loan terms and interest rates.
Credit evaluation is an important part of my PreApprovalprocess. If we need to deal with a credit issue, that's the best time to do it...before it affects your financing contingency or closing dates.
Whether or not your buyers have credit concerns, have themcall me when you first start showing them homes.
Being prepared, well-informed, and knowing their options helps them submit offers that sellers take seriously and end up at the closing table.
Let me reinforce the trust
your buyer has placed in you! sm
All information provided by Chris Carter. Contact information below.
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