Are you one of the ~40 million American households who rent and would like to purchase a home in the near future? Do you already own a home and want to purchase another one? Are you thinking about refinancing your existing loan?
Yes...maybe...someday? Read on!
FICO is king! In today's mortgage market, your FICO score and loan-to-value are the main factors that determine your rate and price for a Conforming loan, which is a home loan that meets Fannie Mae & Freddie Mac guidelines and has a loan amount of up to $453,100 (or up to $679,650 in certain high cost areas of the U.S.). Contrary to popular belief, having extra money in the bank or a low debt-to-income ratio have NO impact on the rate or pricing for a Conforming loan. These are however, compensating factors that can help you qualify for a riskier loan (e.g., investment/rental property, cash-out refinance, high loan-to-value, etc.).
Fair Isaac Corporation, the company that produces FICO scores, has a consumer website called My FICO which provides valuable information about the credit scoring system. Now that 90% of the top U.S. financial institutions use FICO scores to make consumer credit decisions, it is critical for consumers to understand the credit scoring system to maximize their FICO score before applying for financing. Set aside an hour to browse their site so you can truly understand what goes into a FICO score and adopt best practices on utilizing credit. It will be one of the best investments you make of your hour spent! Believe me!
While you can't change your past credit habits, you can control how you manage and utilize credit going forward. Following the steps outlined below will boost your FICO score and help you qualify for a better mortgage rate with less hassle. To ensure you have a smooth loan process, it requires some preparation on your part as well.
1) Obtain a copy of your credit report from all 3 credit bureaus at least 2 months prior to applying for a mortgage or pre-approval
All consumers can obtain a copy of their credit report free of charge annually from www.annualcreditreport.com.
From this website, you will be able to order a copy of your credit report from the 3 major credit bureaus: Transunion, Equifax, and Experian. Please note that pulling a copy of your own credit report is considered a "soft inquiry" and will NOT impact your credit score. Click here for more information about inquiries and how they affect your FICO score.
For a major purchase such as buying a home or refinancing an existing mortgage, it is best to pull all 3 reports at once to ensure the data is correct at all 3 bureaus. Then, it is often useful to stagger and pull one report every 4 months to monitor your credit regularly. Additionally, you can join a free credit monitoring service like Credit Karma, now used by over 35 million Americans.
If you do not review your credit report prior to applying for a mortgage or pre-approval, you may receive an unpleasant surprise. Loan originators do not enjoy being the bearer of bad news for any of the following derogatory credit items:
- a current or past creditor reported a 30+ day late payment
- an account submitted to collection (forgot to update your mailing address in the past with a creditor or medical provider and never received the bill?)
- too many accounts "in dispute" status (Freddie Mac will not lend to a borrower with too many accounts "in dispute" status; 1 or 2 accounts "in dispute" status is typically acceptable; Fannie Mae will require all accounts "in dispute" status to be resolved prior to loan approval. Note: All accounts "in dispute" status are excluded in the calculation of your FICO score.)
- a judgment you thought was resolved (but still appears as status "unknown")
Learning about these issues from your lender for the first time can be costly for several reasons:
- A recent 30+ day late payment or collection account can significantly lower your FICO score If you had a pristine 800+ FICO score, you may have lost about 100 points. If your loan-to-value ratio is over 60%, this negative impact will require you to pay anywhere from a 0.25 to 3.25 points more to obtain the same interest rate compared to a borrower with a 740+ median FICO score. On a $200K loan, this would be a penalty of $500 to $6,500! Alternatively, you may have to select a higher rate to offset some of the additional point cost, or may not qualify at all if your median FICO score drops below 620, which is the cutoff point for most lenders underwriting to Conforming loan guidelines. Thus, one 30+ day late payment or a tiny $15 collection account can cost you thousands more in closing costs and/or additional interest over the life of your loan, or make you lose the home of your dreams to a better qualified buyer!
- Your lender may need to re-pull credit after you fix derogatory items to qualify you for the loan or obtain a better rate/price If it takes you more than 2 weeks to successfully dispute or repair your credit and the lender's 2nd credit inquiry is not done within 14-days of their original credit pull, some lenders will consider that a separate credit inquiry. As most consumers already know, having too many inquiries can lower your FICO score. Too many inquiries may knock you down to the next pricing tier for a loan. On a Conforming loan with a loan-to-value greater than 60%, pricing gets increasingly worse every 20 points below a 740 FICO score (e.g., 740, 720, 700, 680, 660, 640, 620).
- Rates may increase during the time it takes you to repair your credit
By monitoring or reviewing your credit at least 2 months prior to applying for a mortgage or preapproval, you will allow yourself ample time to dispute any derogatory items found on your credit report. Most disputes can be resolved within 30-days.
2) Limit use on credit cards or reduce balance owed before end of billing cycle
Credit card companies usually report the statement balance--the balance at the end of your billing cycle--to the credit bureaus. Try to pay your balance down BEFORE the end of your billing cycle so the lesser balance gets reported to the credit bureaus. Even if you pay your statement balance to $0 every month during the payment grace period, your FICO score will likely decrease if you have a high balance to credit limit ratio (aka "credit utilization" ratio).
3) Resist the urge to apply for new credit until after your loan has closed
Think twice before financing that car or opening a new credit card for store discounts or bonus points/rewards. New accounts will lower your average account age and likely lower your FICO score. Although 740 is currently the minimum median FICO score to qualify for the best Conforming loan rates, a 760 minimum median FICO is required to qualify for the best mortgage insurance rates. Mortgage insurance will most likely be required if your loan-to-value ratio exceeds 80%.
4) Don't close unused credit cards
This may lower your average account age, if it is an old card, and lower your total available credit limit. Both effects will have a negative impact on your FICO score.
5) Pay bills on time
Next time I will discuss how a lender analyzes your assets (Part 2), and then the importance of receiving a conditional loan approval prior to making an offer on a home (Part 3).