The Good, Bad and the Ugly
The Good, Bad and the Ugly?
Understanding credit scores to help you convert denials into dollars.
It takes a lifetime to build a solid credit report, and only 30 days to destroy it, a frightening but true fact-of-life. The mortgage industry revolves around credit scores, yet many of us don't understand the dynamics of credit reporting.
What makes up a score, how can we help borrowers improve scores and their credit reports as a whole? Here are the answers!
Credit scores, or FICO scores, were developed by Fair Isaac Corporation in an effort to create a less subjective or less personal system that would analyze the level of risk a company faces when lending to a borrower. Over the last 20 years, FICO scoring has become the system most commonly utilized by lending institutions. There are three different credit reporting agencies that have all developed their own version of the FICO scoring model: TransUnion (Emperica), Experian (Fair Isaac), and Equifax (Beacon). These scoring systems will produce numbers ranging from a low score of 350 up to a perfect score of 900. Even though the formulas are protected as proprietary information, we do have a good idea of what factors affect credit scores:
1) Approximately 35% of a credit score is affected by payment history. How many late payments does the borrower have in the last 24 months, how many trade lines have reported late payments and how many accounts were sent to collection, charged-off or included in bankruptcy? Rule of thumb, the more recent the occurrence (positive or negative) the more heavily the credit score is affected.
2) Nearly 30% of a credit score is the reflection of open, outstanding debt. How many accounts does your borrower have with outstanding balances? What is the ratio of available credit to current balance on each open account? The best advice here is to limit credit card balances to 50% or less of the high credit limits.
3) Another factor is time; how long has your borrower existed in the credit bureau? This makes up about 15% of the score. The longer the history, the more positive the score.
4) The remaining 20% of a credit score is determined by smaller factors. Multiple recent inquiries on the bureau and newly opened credit lines may affect the score in a negative manner. Multiple, recent inquiries are looked upon negatively as they may indicate that the borrower is in financial trouble or that they are about to take on a large amount of new debt. However, inquiries are only counted in the score for 12 months and occasional pulls are not viewed to be negative. What type of activity do you see in the borrower's report? How many credit cards vs. installment or mortgage loans are they currently carrying? A healthy mix of open and active installment loans combined with a few, low balance credit cards is the optimum way to maximize scores.
"Many consumers underestimate the importance of building and maintaining a strong credit history",says Dean Harris, founder of Credit Resolution Services. They don't realize how scores affect more than just the interest rates they pay on loans. Insurance premiums and overall buying power are also factors that can be affected by credit scores. Dean helped to shed some light on ways that we can coach borrowers into increasing their scores or repairing their credit. Here are several tips you can pass on:
1) Make all payments on time. Sounds simple, but many borrowers underestimate the importance of timely payments. Help them understand that every month presents an opportunity to increase credit scores!
2) Review trade line information to ensure accurate reporting. Make sure that old, inactive accounts are closed. Document and dispute any reporting errors, outstanding collections and charge-offs with all three bureaus.
3) Remind borrowers that seasoned accounts (with good history) score higher, and recommend that they do not close their oldest accounts. Instead, help them negotiate better rates on those credit cards or note loans in order to lower payments. Re-organize outstanding debt by paying debts down or off. Suggest that they request an increase in credit limit (not intended for using the credit) in order to lower balances below 50% of the high credit limit.
4) Be educated on the importance of limiting credit inquiries. Individuals can obtain a free report from each credit reporting agency once annually by contacting Annual Credit Report Service at www.annualcreditreport.com, 877-322-8228. Obtaining a copy of their own reports is not considered a hard pull, therefore will not affect scores and will allow skeptical clients to safely shop their options.
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Diamond Street Mortgage, Inc. • 200 N. Broadway Suite 100 • Wichita, Kansas • 316-771-5111
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