Guide: Understanding Credit Scores & The Impact on Your Mortgage

The Tale of Two Buyers

Sam is a lucky guy. He’s sitting on over $300,000 in home equity and he’s about to sell his house in this hot market. He plans to downsize into a maintenance-free condo in preparation for retirement sometime in the next 10 or 15 years. He’s a big Dave Ramsey fan, so he’s dutifully paid off his high-interest, revolving credit cards and closed most of the accounts, plus he saved up to buy a used Ford F-150, cash. The one credit card he keeps open, he makes sure to pay off in full every month, no matter how high the balance. He hasn’t put much into his 401k, given how much cash all this debt-mowing has required, but there’s still lots of time, he figures, since he’ll only have a small mortgage on his next home when he plunks down mostly cash.

You wouldn’t think of Sam as the kind of guy who needs credit advice from the experts at Guild Mortgage Inlanta Grand Rapids. And you’d be wrong.

“Credit reporting is counter-intuitive. Often, it’s the solid, steady folks who are shocked to learn that while they may have managed their money admirably, their credit scores are quite a bit lower than they could be, and therefore their interest rates may be higher,” says Jonathan Arnold, Branch Manager of Guild Mortgage Grand Rapids.

“Nine out of every 10 people we talk to can save tens of thousands of dollars in interest if they talk to us the moment the notion to buy, sell or refinance occurs to them. It’s important, and the sooner they see us, the faster we can help them boost their scores.”

Meanwhile, across town, there’s Jane, ready to pick up the phone and call Guild Mortgage. She’s quite a bit younger than Sam, and earns substantially less. On top of her student loan and car loan, she has a number of credit cards, all carrying a balance. She’s paying more than $1,000 a month renting a duplex apartment. She’s not even sure she’d qualify for a mortgage, but her parents have offered to help with a down payment. She’s missed a few student loan payments seven years back, but has managed to keep her accounts current.

You wouldn’t think that Jane’s credit score would be higher than Sam’s, but you might be wrong. If Jane keeps her credit utilization to less than 30% and continues to stay current on her payments, Jane could see a higher score, and lower rate, than Sam.

It sounds crazy, but that’s how credit scores work. Guild Mortgage counsels clients to arm themselves with an understanding of credit scores and mortgage criteria to get the best rates they can. Armed with knowledge, you too can develop lifelong financial savvy. By the end of this guide, test your knowledge and guess how Jane’s score can be higher than Sam’s!

Knowing What You Don’t Do

NerdWallet.com recently commissioned a survey to assess the credit knowledge of Americans. The survey found that most Americans don’t know the effect that many common actions have on their credit scores, and that fewer than 9% of respondents knew there are more than three different credit scores. Despite a depth of knowledge about when and how interest was charged on their credit cards, the survey found the average American household carries $16,748 in credit card debt.

In an effort to help educate consumers and Realtors about the ins-and-outs of mortgage financing, Guild Mortgage periodically gives lunch & learn talks on the topic. The following tips form part of Guild Mortgage loan officer, Brian Ferrick’s presentation:

Knowing the Score on Scores: Consumer Scores Vs. Mortgage Scores

• FICO Credit can range from no credit to scores between 300 and 850
• 750+ is considered excellent credit
• There are 3 Bureaus who report credit that all banks use to determine credit worthiness. They are: Experian, Equifax, and Transunion.
• However, the types of free online scores most consumers see are actually different than what a lender uses.

A consumer score is meant to be educational. All information is the same that will be found on a mortgage report, but the weight given in scoring is completely different. The idea is that the consumer can see how they compare to national averages and can catch errors. Mortgage scores are based on FICO Scores, which have many different versions and the newest model is rarely used right away in the industry.

Generally speaking, myfico.com is the only source to get your true “mortgage” scores. Of the FICO scores, there are different types of scores used by auto lenders, credit card companies, and mortgage companies.

Impact of Credit Score on Mortgage Rates

Borrowers with high credit scores tend to get lower interest rates on mortgages than borrowers with low credit scores, though some government-backed mortgage programs can offer competitive rates.

• A credit score of 740 or higher qualifies for the best interest rates from most lenders.
• Unlike most mortgage lenders, Guild Mortgage Grand Rapids has a special program where it’s possible to get a new home loan with a credit score of 581.The difference between the best and worst rates can vary by a full 1.5%

Example:
According to myfico.com, a person with a FICO^® score of 700 or better will pay $176 less a month on a $216,000, 30-year fixed rate mortgage than someone with a FICO score of 620. Someone with 760 or better will pay $203 less per month.

The cost difference initially can be $2,112 – $2,436 a year!

Lenders Weight Your Credit Report Elements Differently

• Payment History (35% of score)

  • Payment information on all your credit accounts
  • The most important thing a lender wants to know is if you make payments on time

• Amounts Owed (30% of score)

  • Total amount owed on all credit accounts
  • Amount owed on individual credit accounts
  • How much of the total credit line is being used

• Length of credit history (15% of score)

  • How long you’ve had an established credit history
  • How long each account has been established
  • How long since you’ve used certain accounts

• New Credit & Inquiries (10% of score)

  • How many recent requests for credit you’ve had
  • Applying for too much credit in a short period of time can hurt your score

• Types of Credit (Mix) (10% of score)

  • Includes the total combination of credit cards, car loans, retail accounts, etc., you have in your name.

How Government-Backed Lenders Use Credit Scores

Guild Mortgage Grand Rapids is licensed to offer government-backed mortgage programs such as FHA mortgages, VA mortgages, USDA mortgages and MSHDA mortgages. As such, many of our clients are interested in knowing how these programs view credit scores.

• Fannie Mae, Freddie Mac, VA (Veteran’s Administration home loans), USDA (Rural Development) home loans, and FHA (Federal Housing Authority) all use the middle of the three scores as the score of record.
• If 2 scores only, they will use the lowest score.
• If 2 people are on a loan they use the lower of the 2 scores.

What Scores are Needed for Each Mortgage Type:

• Conventional: 620, 740 or higher gets you best rates, 760 or higher gets you the best MI rates
• FHA: No score minimum, but usually need 620-640. 580 if you just have some medical collections
• VA: No score minimum, but usually need 620-640. 580 if you just have some medical collections
• USDA – RD: 640 score is required, there is a gray area below that you MAY be able to go lower but 640 is usually required.

How Do Student Loans Affect Scores?

Student loans affect credit scores in a variety of ways. They will be calculated as a factor in your debt-load ratio, and form part of your credit utilization calculation. Timely payment will contribute to your positive credit record. Most people with student loans are concerned about the impact of loans on their ability to achieve an acceptable debt load ratio. Generally, lenders calculate 1% of the loan as a monthly obligation.

• Over limit: One negative impact occurs when a student loan is new. Current limits may be higher than original balances if no payments were made while in school, which makes it look like you’re “over the limit”
• Conventional Mortgages: 1% of the outstanding balance or the fully amortized payment, whichever is greater
• FHA Mortgages: 1% of the outstanding balance, payment on credit report or the fully amortized payment, whichever is greater
• VA & USDA- RD Mortgages: 1% of the outstanding balance or the fully amortized, fixed payment

Effect of Bankruptcy and/or Foreclosure on Credit Score:

• Conventional: Chapter 7 Bankruptcy, short sale, pre-foreclosure, deed in lieu, and mortgage loan charge-off are all a 2 year waiting period. 7 Years on a foreclosure. Chapter 13 Bankruptcy ** Special circumstances **
• FHA: Chapter 7 Bankruptcy is a 2-year waiting period. 3 Years on a foreclosure. Chapter 13 Bankruptcy ** Special circumstances **
• VA: Chapter 7 Bankruptcy, Foreclosure 2 years. Chapter 13 Bankruptcy** Special circumstances **
• USDA-RD: Chapter 7 and Foreclosures are 3 years, Chapter 13 Bankruptcy** Special circumstances **

Facts on Judgements, Tax Liens, and Collections

Conventional, FHA, VA, & RD: Judgements & Tax Liens need to be paid, sometimes they will allow proof of a payment plan that’s been paid on time for 6-12 months. There is no requirement for collections to be paid unless the findings state some need to be paid unless they are over $2,000 or overall amount is $2,000. Medical collections are mostly “OK”, but not if they are a large sum of money. Each situation must be evaluated individually.

How to Prepare for a Mortgage

Consulting with an Guild Mortgage Guild Mortgage Grand Rapids team member early in the process will help you save money and have a bullet-proof closing when the time comes.

“We’d rather see someone the moment they have a notion to begin house hunting…not after they’ve made an offer. Our team members are trained to help clients strategically navigate their options, and planning ahead is usually more than worth it,” Arnold says.

That can include savvy ways to leverage existing assets for down payment, and taking action to improve your score before applying. Here are the general tips:

• Have a mortgage professional pull credit and make sure there is nothing major to be addressed between now and the time you want to purchase a new home
• Continue to pay all bills on time
• Do not open any new credit
• Pay down credit cards to below 30% of limit to maximize scores
• Do not get any collections or judgments, even for medical
• Save for down payment in a savings account

Quick Tips for Buyers in Process of a Mortgage

Nothing is more frustrating for would-be homeowners, and Guild Mortgage team members, that to see a great deal scuttled on the eve of closing because of credit changes at the last minute. For this reason, the following Dos and Don’ts are critical:

DO’S – Keep paying all bills on time, continue using credit as usual but not increasing balance amounts after payments, keep current job, if not call and discuss before any moves.

DON’TS – Pay any bill late, change jobs or become self-employed, change bank accounts, put cash in your account, move any money around, pull new credit, get a car, co-sign for anyone, use any of the money you had planned for the down payment.

Important Credit Tips for Everyone:

• Consistency long-term is key to a great credit score
• Everyone should check their credit annually: annualcreditreport.com (FREE)
• You must use credit to have credit
• Keep old accounts open
• Don’t request lower limits on open accounts
• Keep credit pulls to a minimum

So, are you ready take control of your score? Review the Sam vs. Jane scenario and then feel free to give us a call at (616) 918-6564 or Contact Us to get started!

Review: Sam Versus Jane

Sam’s problems:

1. Sam lost positive history and score weight by closing credit cards, which would have contributed to a low utilization percentage. For example, if you have a total of $20,000 credit available and used only $5,000, you’re at the desirable 25% utilization. Now that Sam is down to a single card with a $10,000 balance, a month where there’s $5,000 in charges, even if paid in full at the end of the month, might report as a 50% utilization – which negatively affects his utilization score, worth 35% of his overall report weight.
2. By paying off the credit cards and not having a car loan or mortgage, Sam will not have the desirable mix of credit lines lenders prefer to see. He has also depleted his cash reserves by buying the truck. Mortgage lenders like to see 6 months worth of income in savings.
3. Sam has left himself unable to buy a new condo until he sells his house. He will not be able to bid competitively on a condo without a down payment available.
4. Sam’s plan to take a small mortgage and use sale proceeds to pay for the condo will not likely benefit him financially in the long term unless he is ALSO able to contribute the maximum to his 401k. Given that the market typically performs at a better rate than the current cost of mortgage interest, he’s losing the compound interest of putting more money into his 401k, and at the same time, by mortgaging less, losing the tax advantage of deducting interest from his itemized taxes.

Sam’s Solutions:

1. Sam could reopen some of his revolving credit accounts and have small monthly payments be charged to them. He could distribute his credit card charges across different accounts, ensuring he does not exceed 30% utilization.
2. Sam would be well-served to investigate a HELOC before listing his house for sale. He would then have the cash available to purchase a condo when he finds the right one.
3. Sam would likely have substantially more money in his retirement fund in 15 years if he used a large share of his proceeds to aggressively contribute the maximum each year for the next several years, and mortgaged a higher amount (but not more than 80% to avoid mortgage insurance).

Jane’s Situation:

1. Jane’s late payments on her student loans were 7 years ago, which means they would have been removed from her credit report. If they were newer, Jane would be advised to submit a goodwill letter of request asking that given her better track record, the late report be removed.
2. Jane’s revolving credit has fortunately been kept under 30% utilization. If it wasn’t, Jane would have been counseled to aggressively pay down balances above 30%, and to open new lines where possible to tweak the ratio.
3. Jane might feel like she has a lot of debt, with a student loan, a car loan, and credit cards, but on balance, credit bureaus view this as an ideal mix, provided payments are current and within an overall debt load ratio of 42% of gross earnings.
4. Jane’s parents helping with down payment might also improve Jane’s rate if they offer 20%, which means Jane would not have to pay mortgage insurance in a conventional mortgage. However, even if Jane’s parents only have 3-5% available to put down, with a score above 720, Jane will still qualify for a very competitive rate in any of the federal programs.

This guide was last updated June 2017