Most
anyone who has obtained a home mortgage in the past
5 years or so has heard about credit scoring. How many
of you have been told "your scores are great", or "if
your score were 10 points higher, your rate would be
better by 1/4 point"? Probably most of you.
We
in the industry started to become aware of "scoring
models", as they are called, as early as 1994. The use
of scoring models in the mortgage industry came about
as the major secondary market players, known as Fannie
Mae and Freddie Mac, started to develop automated underwriting
systems. They had been in use for a long time for auto
lenders and credit card issuers.
The
early creators of the automated underwriting systems felt
that, if someone could go to a Mercedes dealership at
10 am and drive off the showroom floor an hour later with
a $100,000 car (still more expensive than homes are in
many parts of the country), they ought to be able to obtain
a home loan the same way. The logic in this should be
obvious... after all, cars are rolling stock, so they
can disappear, they depreciate and usually people don't
live in them. Houses are attached to a foundation, they
usually appreciate and people usually live in them. Using
that logic, the industry should be able to make the home
buying process easier for everyone.
This
theory sounds good, but it is only in the last year that
we have seen some relief from the mountains of paper that
go into loan files, and it is because the scoring models
have become more refined. Still, there is progress yet
to be made and the industry is grinding slowly in that
direction. Scoring models figure prominently in the future
of how people obtain home mortgages.
Most
people know that most creditors use credit reporting agencies
for obtaining information on a person when they have applied
for any type of financing. However, there are actually
two levels of credit reporting agencies. There are three
major repositories of credit and background information.
They are Equifax, Experian and TransUnion. When someone
obtains credit, the creditor reports the payment history
to these repositories. This is usually done monthly but
may be done on an irregular basis. These repositories
simply accept the information as it comes in electronically
and they DO NOT check the accuracy of the information.
The
credit repositories and other agencies also maintain
other background information on every person in the
country who has a Social Security number or other identifying
information. The other agencies may include the Department
of Motor Vehicles, the Medical Information Board, the
FBI, local law enforcement agencies, the county recorders
for each county (public records repositories), etc.
Even the mortgage industry has a central repository
for borrowers and lenders who may have been involved
in fraudulent activities in the making of mortgage loans.
When
you apply for a mortgage, your lender will request a credit
report from a credit reporting company. This is usually
a local or regional company. This company pulls together
a credit report electronically. It usually comes from
one or more of the major repositories, but it can come
from several sources.
Along
with the information, the local credit reporting company
receives a numerical score. The score represents a composite
of the borrower's credit history, employment, ability
to save, and so on. The most famous of these scores is
known as the FICO score, which was a model developed by
the Fair-Isaacs company a number of years ago. It is believed
that the Beacon and TransUnion scores are really scoring
information provided by the Fair-Isaacs Company, but have
been tweaked somewhat by the other bureaus. That is partly
true, but what most people don't know is that, with information
streaming into their credit file almost everyday, the
scores can change daily. That is why someone can apply
for a mortgage with one company today and have a FICO
score of, say, 717, and apply with another lender a week
later and that score can be higher or lower, depending
on the information received at the repositories in the
interim.
The
truth is that the Fair-Isaacs Company and the major credit
repositories do not divulge how the scoring model works.
Due to the level of erroneous reporting to peoples' credit
files, there has been pressure on Congress lately to make
the credit repositories more accountable for the accuracy
of the information they report AND to divulge what goes
into the scoring models, so that people can know what
to do to improve their scores.
Why
is this important? Because the lending industry is moving
toward "risk-based" pricing. In plain English, this means
that the higher one's credit scores, the less paper they
will have to provide to prove that they are creditworthy
AND the interest rate and/or fees a borrower pays will
be based on the level of their scores.
This
system, while perhaps unfair to some, will be great for
those who maintain impeccable credit. It's one way that
good credit risks can be rewarded. In the past year, we
in the industry have already seen a dramatic reduction
in paperwork requirements and "risk-based" pricing (rates
and fees) has become commonplace.
If
you have recently obtained your credit report and you
are not happy with what was reported, you can take steps
to correct the erroneous information on it. There are
also proactive things you can do to improve your scores,
if you are anticipating applying for a mortgage anytime
soon. While I intend to go into the details of correcting
erroneous credit information in Part II, I can give you
a few hints now as to how to be proactive in improving
your scores from where you are today.
The
first is the most obvious. Pay all your payments on time.
The second is, don't apply for any new credit unnecessarily.
Every time you sign and return a new credit card offering,
or open that second account at a department store because
you get a 15% discount, an inquiry will be generated and
that will reduce your score. The third is, if you must
maintain credit card balances, try to keep them at a level
that is 35% - 40% of the maximum credit limit. In other
words, if the credit limit is $1,000, try to keep your
running balance below $400. Believe it or not, consolidating
all your credit cards onto one can hurt you, if the balance
is at the credit limit. The fourth is, if you get into
a dispute with the phone company and it isn't a huge amount,
pay it and move on. Having one or more collections, even
if they are small amounts, can really hurt your score.
Reach
Your Goals with an IRA!
Contributing
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independent.
Do
You Have Access to a 401k?
Top
401k Mistakes 1.You
miss out on the match 2. You pick the wrong funds
3. You don't rebalance. But there are mistakes,
and there are Hall of Fame mistakes that can torpedo
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Don't
Have Any Money to Save?
Don't
Make This Mistake!
The
biggest mistake you can make is assuming you don't
have any money to save. If you earn an income, it's
simply a matter of how you're spending it. You
can put some money aside each month - if you make
saving for your future a priority.
