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Credit Scoring Guide
In a nutshell, credit scoring is a
statistical method of assessing the credit risk of a loan applicant. The score
is a number that rates the likelihood an individual will pay back a loan. The
score looks at the following items: past delinquencies, derogatory payment
behavior, current debt level, length of credit history, types of credit number
on inquiries.
Credit scoring will place
borrowers in one of three general categories:
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First, a borrower with a score 680 and above may be considered an
A+ loan. The loan will involve basic underwriting, probably through a
“computerized automated underwriting” system and be completed within minutes.
Borrowers falling into this category may have a good chance to obtain a lower
rate of interest.
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Second, a score below 680 but above 620 may indicate underwriters
will take a closer look at the file in determining potential risks. Borrowers
falling into this category may find the process and underwriting time no
different than in the past. Supplemental credit documentation and letters of
explanation may be required before an underwriting decision is made. Loans
within the FICO scoring range may allow borrowers to obtain “A” pricing, but
loan closing may still take several days or weeks as it does now.
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Third, borrowers with a score below 620 may find themselves locked
out of the best loan rates and terms offered. Mortgage professionals may divert
these borrowers to alternate funding sources other than FNMA and FHLMC.
Borrowers may find the loan terms and conditions less attractive than the “A”
loans, and it may take some time before a suitable funding source is located.
As more companies utilize credit scoring, the loan approval
and closing time will be compressed for most consumers. In the future, a high
FICO score may be your ticket to a speedy and competitively priced mortgage
loan.
Credit Scoring
Credit scoring is a quick,
accurate and consistent scientific method for accessing credit risk. Your credit
scores are based on data stored by a credit repository about your credit history
and payment patterns. Credit scores are calculated by statistical models that
assign points to factors indicative of repayment. These scoring models exist
in software utilized by credit bureaus or lenders. Credit scores are based on
data rather than human judgment, making credit scoring an objective risk
assessment tool as opposed to a subjective, possibly discriminatory, human
interpretation of information. Even the best underwriter cannot match scoring’s
statistical ability to weigh and measure hundreds of factors and reach a number
indicating relative credit risk in a matter of seconds. The resulting score
is a “snapshot”. It sums up what your past payment performance and current usage
of credit say about your level of credit risk to the lender. Because the score
is a composite of all the applicants’ credit information, NO single factor like
a late payment or even a bankruptcy will be the sole cause of an unacceptable
credit score.
What Data is a Repository
Scoring Model Based on?
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Scoring
Models Do Not consider- Race, gender, religion, marital status, income,
nationality, neighborhood, employment history, position or title, sexual
preference, or interest rate being charged on a particular card.
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Scoring Models Do include- not just the
negative credit information such as late payments and bankruptcies, but also all
the credit information stored in the repository’s credit file on you at the time
of the request.
Past Payment
Performance (35% of the Credit Score’s Weight)
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The fewer lates, judgments, liens or collections, the better. Zero
negative entries on your reported derogs usually indicate lower risk.
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Recent lates are more indicative of future default by you than
those that occurred more than 24 months ago.
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A 30-day late by you today will have a greater negative impact on
your score than a bankruptcy five years ago with clean credit ever since.
Types of Credit in
Use (30% of the Credit Score’s Weight)
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Low balances on several credit cards are better than
high balances on a few cards.
(Balances on your cards should be dept at or below 30% of the potential
credit limit.)
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Too many credit cards can be detrimental.
Warning: Do not close any of your accounts
without first discussing your complete credit profile with your mortgage
professional. Your score could go down.
Credit
History (15% of the Credit
Score’s Weight)
·
The longer accounts have been opened, the lower the risk
indications are about you.
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Opening new accounts and closing your seasoned accounts will
negatively impact your score. AVOID “credit surfing.”
·
Established credit history is relative to your past payment
performance and how high or low you credit usage may be.
·
A short credit history does not automatically indicate that you
are a high credit risk, as long as you are not a heavy user of credit and your
payments have been made on time.
Keep your balances on cards LOW! To get a score, you should have two accounts
that have been opened for at least six months.
Types of Credit in
Use (10% of the Credit Score’s Weight)
·
Finance company accounts will score lower than the accounts you
secure through banks or departments stores. (Appears that you could not qualify
for a better type of credit).
·
“90 days same as cash” and deferred payments generally are funded
by finance companies.
Inquiries on Your
Report (10% of the Credit Score’s Weight)
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Looking for a new credit can indicate higher risk if several
credit cards are applied for in a short period of time and your existing cards
have been charged to their maximum limits.
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Multiple inquiries, regardless of the number, for mortgages or
autos, in a 14-day period of time, only count as a single inquiry in their
impact on your score.
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Any mortgage or auto inquiry made about your credit file within 30
days of the current lender’s inquiry, will not impact your score due to buffers
within the credit-scoring model.
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Promotional or administrative inquiries shown on your credit
report do not adversely impact your score.
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Only the first seven inquiries made by different trade lines
(credit cards) shown on your credit report will actually be factored into the
impact on your score. Only inquiries authorized by you for the purpose of
being granted new credit lines will impact your score.
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What this means: When you open a charge account
with (for example) Sears. Sears may periodically inquire into your credit to
see if you qualify for additional promotions-or- your lending institution
(example: B of A) may periodically inquire into your credit to see if you
might be in financial jeopardy, bankruptcy, or qualify for additional lines
of credit (i.e.; auto loan, etc)
How Does Credit Scoring Help You?
Credit
scoring is not a crystal ball, but it helps lenders make more informed decisions
and offers real benefits to the consumer.
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Credit scoring evaluates all applicants by the same
criteria. Opinions do not enter the scoring equation.
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Changes in your credit performance will change your
credit score. While “scoring scales” remain constant, your place on the
scale will change as your individual credit patterns change.
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Scoring speeds up credit decisions. Scores help
lenders make decisions more rapidly, and often with less documentation.
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Scoring helps make more credit available to the
borrowing public. With more credit available, the cost of credit to you
decreases.
How to Improve Your Credit
Profile and Score?
There is no magic to improving your credit
score. Credit scores automatically improve, as your credit profile gets better.
Improving your credit profile isn’t always a quick fix. Here are a few things to
remember:
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Pay down all of your credit card balances to below 30%
of the available credit balance.
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Do not consolidate accounts on to one or two cards and
close other accounts. Low balances on a few cards are better than high
balances on the one or two credit cards you still have left open.
Consolidation of your balances will artificially skew the appearance of your
credit utilization.
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Keep the number of credit cards you own to a
conservative number, but don’t close accounts without the advice of a
knowledgeable mortgage broker.
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Review your credit report for accuracy at least 90
days before you intend to apply for a mortgage. Have any errors on your
report corrected at the repository that is reporting the erroneous
information.
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Understand that paying off a collection account or
judgment, for example, will not eliminate it from your credit profile. Paid
or satisfied negative credit items will show a zero balance, but will not
disappear from your credit profile for seven years. They still reflect a
late or a collection account even if you paid it off.
The Fair Credit Reporting Act
Millions of Americans can more easily get access to
their credit report and to correct any errors thanks to the Fair Credit
Reporting Act. This is important to you because businesses use credit
reports to decide whether you can borrow money or not.
If you want to contact any of the three major
credit bureaus- Experian (formerly TRW), Equifax, and TransUnion- here are their
main numbers along with the numbers to call if you want to get off mailing
lists:
|
Credit Bureau |
Main Phone
Numbers |
To Get Off
Mailing Lists |
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TRANSUNION
EQUIFAX
EXPERIAN
|
1-800/888-4213
1-800/685-1111
1-888/397-3742 |
1-800/680-7293
1-800/566-4711
1-800/353-0809 |
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Features of The Fair Credit Reporting Act
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Banks, retailers and others who furnish information to
credit bureaus must clean up their records so errors don’t reappear.
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Credit bureaus must offer toll-free phone numbers.
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Potential employers can’t get a credit report without
a job applicant’s permission. And, before denying a job based on a credit
report.
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The big three credit bureaus (Experian, Equifax, and
TransUnion) must share information so consumers can call one company to have
their name removed for two years from lists of “prospects for pre-approved”
credit offers.
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Penalties for obtaining credit reports under false
pretenses now include big fines and up to two years in jail.
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