Understanding Credit And How Credit Affects Qualifying For Mortgage
This Blog On Understanding Credit Was Written By Gustan Cho NMLS 873293 Of CrossCountry Mortgage NMLS 3029
Credit and Income are the two most important factors lenders will thoroughly analyze prior to granting credit to borrowers. Most borrowers believe that as long as they meet the minimum credit score requirements to qualify for a home loan that they are safe and have nothing to worry about. This is not always the case. It is very important in understanding credit and the importance of the overall credit profile of a borrower and not just the borrower’s credit scores.
Here are some key points in understanding credit for borrowers who plan on applying for a home loan:
- Borrowers should understand that they have three credit scores and that the middle credit score is used by the lender in determining which credit score the lender will use in qualifying credit scores on mortgage borrowers.
- Credit Reports do contain errors and consumers should periodically check their credit reports to make sure that all information being reported on their credit reports are accurate.
- Maxed out credit cards will definitely lower the borrowers credit scores.
- Borrowers should pay down all of their credit card balances months before applying for a mortgage so they can get the highest possible credit scores.
- Higher credit scores means lower mortgage rates and lower mortgage rates translates into tens of thousands of dollars of savings over the term of the mortgage loan.
- Late payments in the past 12 months are considered serious and may be reasons for disqualification for a mortgage.
- You cannot have credit disputes on charge off accounts and non-medical collection accounts that have aggregate unpaid outstanding balances of over $1,000.
- Late payments after bankruptcy, deed in lieu of foreclosure, foreclosure, and short sale may be reasons for not being able to qualify for a mortgage loan.
- If you have foreclosure or deed in lieu reported on your credit report, make sure that you go off the recorded date of your foreclosure and/or deed in lieu of foreclosure as your waiting period start date to qualify for FHA, VA, USDA, FANNIE/FREDDIE Mortgages.
How Are Credit Scores Issued
There are three giant credit reporting agencies that issue credit scores.
Here are the three major credit bureaus who are in charge of issuing credit scores to borrowers:
Which Credit Scores Are Scores Used By Lenders For Qualifying Borrowers
Of the three credit scores, all mortgage lenders will use the middle credit score of the borrowers to process the mortgage loan.
Here is a loan scenario on how lenders use the middle credit score in qualifying borrowers:
- For example: If a client has credit scores of 620, 650 and 700, use the middle score of 650.
- The middle score must be at least 620 for most loan programs and lenders.
- Credit scores fluctuate and many lenders will have a tool called FICO Analyzer which will render potential credit score improvements once you enter a borrowers tri-merger credit report and credit scores.
- It will give you a line item per line item rescoring formula where it will state the number of FICO points you can have by paying down certain credit tradelines or paying off a collection/charge off account.
What Is A Credit Score Analyzer?
Many loan officers use a tool called the FICO Analyzer where it will get you a step by step re-scoring instructions on what a borrower needs to do to maximize his or her credit scores.
The FICO Analyzer will give you the following results:
- It will give you a potential credit score improvement by paying down certain revolving credit accounts.
- It will give you a potential credit score improvement by removing certain credit tradelines like removing authorized credit card user accounts, especially for authorized credit card revolving tradelines with maxed out credit balances or history of late payments.
- It will give you potential credit score improvements by paying off judgments, tax liens, collections, charge off accounts.
- It will give you potential credit score improvements if you were to pay off certain installment debts.
Understanding Credit And Credit Reports
Understanding Credit, Credit Scores, and being able to read credit reports is not as difficult as it may seem. The first lesson to understanding credit is to realize that your credit report is made up of four different parts.
Credit reports are divided into four sections and the combination of these four parts is what makes up your credit scores:
- Identifying information, credit history, public records, and inquiries.
- Identifying information is just that – information that relates to identify the customer.
- Be sure to look at this information closely for accuracy such as wrong social security numbers, misspelling of your first name, middle name, or last name. wrong date of birth, and wrong information of you address.
- Credit History: The credit history section is where you will see the individual credit tradelines .
- This part of your credit report will also not the type of credit you have established such as installment or revolving accounts, whether it is an active credit revolving or installment account or closed accounts.
- You will also see the date of last activity and the high credit limits and your current balance.
- There will also be comments such as account in credit dispute, account in collections, account charged off.
- You will also see the high credit limit and balance on the account.
- You may also see comments like: collections, charge‐off, or account in default.
- Below this section, you will also see a section that will report public records such as judgments, tax liens, bankruptcies, foreclosures, short sales, or other public records.
- The final section on the credit report is inquiries.
- Credit inquiries is done when you give a creditor and/or employer permission to have access to your credit report.
- It is normally done when you apply for new credit or when you apply for a new job.
- Anytime anyone, including you accesses your credit report, an inquiry is generated.
Understanding Credit Inquiries
Credit Inquiries is when you apply for new credit, you are giving the creditor your permission to run your credit either from one or all of the three credit reporting agencies. The creditor will then analyze your credit scores, your credit payment history, and overall credit report and decide whether or not they will grant you credit. Credit Inquiries will show on your credit report and whenever you apply for a mortgage, your lender will want a letter of explanation on all of the recent credit inquiries on your credit report. The way you write a letter of explanation for each credit inquiry on your credit report is every simple. A one line explanation like ” I applied for credit card to get a lower interest rate credit card”. That one statement alone should be sufficient. You will also be asked whether or not credit by the creditor was granted or not and just state whether you were approved or not.
Credit Inquiries are divided into two sections:
- “Hard” inquiries are ones the consumer generates when they fill out a credit application and will lower a consumer’s credit scores. When you apply for credit cards, auto loans, and mortgage loans, those are considered hard credit inquiries.
- “Soft” inquiries are credit pulls from companies that want to send promotional information, or current creditors monitoring their accounts. Soft inquiries only show on credit reports given to consumers.
Hard Credit Inquiries
Hard credit inquiries will have negative impact on your credit scores when you first apply for particular credit.
- For example, if you apply for a mortgage loan for the very first time, the first mortgage company that will do a credit pull on your credit will definitely have a negative impact on your FICO credit scores.
- It may drop 5 or more FICO points. However, if you apply to multiple mortgage lenders in within a 30 days time frame, most of the mortgage credit inquiries after the third hard credit pull will have no impact on your credit scores.
- Same with credit cards as well as auto loans.
- The first few hard credit inquiries will have negative impact on your credit scores, however, after the third hard credit inquiry, it should not affect your credit scores too much.
- You can have 30 plus hard mortgage credit inquiries in a 14 day period and FICO will only count it as one hard credit pull credit inquiry.