You’ve heard the numbers tossed around before — 600, 700, 800 — and you have a specific number assigned to you. But what does this really mean when you want to secure a mortgage? Will your credit score measure up or will you be denied a loan?
“Lending is about taking a risk on the client’s capability to pay back the loan,” says Day 1 Mortgage Loan Consultant Paul Phelps. “With every loan we make, we have to certify that the loan is made in conjunction with ATR — Ability-to-Repay.”
Paul has devoted his career to the real estate and mortgage industry since he first became a loan officer in 1992. He has seen many clients with bad credit, but says there are ways to improve credit scores. “We try not to reject loans,” he says. “We counsel clients and help figure out how to approve.”
An overview of scores
You probably have a score attached to your name through the three main credit bureaus: Experian, Equifax and TransUnion. These scores represent a composite of financial information including your credit history, employment, ability to save, and other factors. Generally speaking, the higher your score, the better your chances are for securing a loan with a low interest rate.
Here’s the typical breakdown:
- 730 to 850 is regarded as excellent.
- 680 to 729 is rated as good.
- 620 to 679 is considered fair.
- 500 to 619 is ranked as poor.
- A score below 500 is generally not high enough to receive a federally-secured loan.
Because the big three credit bureaus often assign different scores to the same person, a “tri-merge credit report” is used by lenders. This means that while they look at all three scores, they usually use the mid score as their starting point when determining loan eligibility.
How low scores happen
So what are some of the biggest reasons for poor credit scores? Paul says that some people just haven’t established credit yet. There’s also an important ratio between the high credit limit versus the balance you have on this credit which should stay below 30%.
“Sometimes people miss payments or walk away from debt,” says Paul. “A late payment on a mortgage loan can be the kiss of death. And sometimes people are simply victims of credit fraud.”
He also emphasizes that while low debt is good, no debt can actually be detrimental to credit, recalling an older couple that had practically perfect credit. Once they retired, they didn’t want debt so they paid everything off and closed their credit card accounts.
The problem with this scenario? “Now there’s not enough information to determine a credit score,” says Paul. “And even reopening old accounts or opening new accounts typically won’t show on a credit score for 12 months, which may be too long for someone who needs a mortgage soon.”
How to establish a credit score
For people who have not established credit and now need a mortgage, Paul’s suggests having at least four open and active tradelines (e.g., credit card accounts, personal loans) that are at least 18 months old. Here’s an example:
- Three revolving credit cards which you pay each month before incurring a finance charge. This demonstrates financial activity.
- One type of installment loan like a car payment or student loan.
According to Paul, the optimal credit score is typically over 700, and you need at least 620 to “be in the game.” Even if you’re in the game, there are different tiers of interest rates that correlate to credit scores. The higher the score, the lower the rate.
How to improve your score
Paul recently worked with a client who had a credit score of 545. She was a single mother with children and had served in the armed forces in Afghanistan. She was now ready to purchase a home and establish roots, but her credit score was too low to obtain a mortgage.
Rather than end the business relationship there, Paul counseled her on how to improve her score. Between March and May, her score increased to 654, high enough to get a VA loan. Things don’t always work that quickly, but Paul does have advice for people who need quick improvement.
“I tell people that the fastest thing to do is pay credit cards down to below 30% the maximum credit amount,” says Paul. “The next step is to get written proof that you have accomplished this. Then get on the phone with one or all of the three top credit score databases (TransUnion, Experian and Equifax). Ask them for an immediate rescore, explaining that you’re applying for a home mortgage. Tell them you need a manual update to your credit score. This still might take 30 days or longer, but by putting this effort into it, you should be able to make your score go up much faster than just allowing the companies to catch up with the updated information.”
Disputing your credit score
According to a 2004 study by the National Association of State Public Interest Research Groups, almost 80 percent of all credit reports contain errors. A quarter of credit reports have errors so egregious that individuals could be denied credit. Common mistakes include inaccurate personal information such as misspelled names, wrong birth dates, “closed” accounts listed as “open,” loans listed twice.
- This Federal Trade Commission site contains good information on finding out what your score is (for free) and disputing a low score.
- Credit Justice Services is an organization founded and led by a group of financial experts. It was created as a network of solutions for consumers who are experiencing unwarranted credit problems.
- If you’re overwhelmed and confused by complex financial terminology regarding mortgages, credit, etc., Day 1 has a helpful glossary of terms.
- Day 1 also has a great list of Mortgage Don’ts and a Mortgage Application Checklist that includes what information and documentation you may need to complete your loan application.
Contact our friends at Day 1 Mortgage for more detailed information.