Credit Worthiness

When a lender is making a credit decision, they weigh what is known as the "3 c's". Credit, Collateral and Capacity to pay. The objective is to weigh the 3 c's and asses a level of risk. How likely, based on analysis of historical performances of mortgage loans, is the applicant going to pay the loan back in a timely manner.

To make a decision regarding credit, lenders usually pull a credit report known as a "tri-merge". This report is the summation of three credit bureaus (Trans-Union, Equifax and Experian). These reports summarize payment history of open and closed credit ie credit cards, installment loans, mortgage loans and cellular service. Any collections, judgements or public records, such as bankruptcy or tax liens are also reported, as well as personal data such as employment and residence history. Payment history is reported on the credit reports for 7 years, however typically lenders are only interested in recent years.

Creditors report monthly to the agencies as to the timelyness of payments. For example, if a payment is due on Feb 1st and is received on time, the credit will report this as an "as agreed" payement. If the payment is made Feb 21st, it would still be considered "as agreed" for reporting purposes because it is not over 30 days late. If the payment is received March 5th, this is over 30 days late, and would be reported as such. (Top of page)

Credit Scoring

Each credit reporting agency calculates a credit score, known as a FICO score. This number is a mathmatical calculation based on an evaluation of various aspects of the credit report as a comparison to historical data of hundreds of thousands of past credit reports. The score identifies the level of risk. Lenders also use scores to predict consumer response to offers sent in the mail, the likelihood that account holders will file for bankruptcy or that a consumer will move their account to another lender. Scores range from approximately 300-850. The higher the number, the lower the risk that this person will default on their credit obligations. It is important to note that each credit agency calculates its own score, and rarely come up with the same scores. Generally lenders will use the middle of the three scores to help determine credit risk. Also keep in mind that credit scores are dynamic. They are constantly changing as new items are being added.

Before credit scores, lenders physically looked over each applicant's credit report to determine whether to grant credit. A lender might deny credit based on a subjective judgment that a consumer already held too much debt, or had too many recent late payments. Not only was this time consuming, but human judgment was prone to mistakes and bias. Lenders used personal opinion to make a decision about an applicant that may have had little bearing on the applicant's ability to repay debt. Credit scores help lenders assess risk more fairly because they are consistent and objective. Consumers also benefit from this method. No matter who you are as a person, your credit score only reflects your likelihood to repay debt responsibly, based on your past credit history and current credit status. (Top of page)

Scoring Factors

No single factor determines the FICO score. Listed are the main categories that go into determining the score, and a rough estimate of its weight.

Payment history: 35%
This is an evaluation of how many times an account was paid as agreed. Were there any delinquencies and if so, how delinquent, how often. Was there 3 times a payment was 30 days late, or 1 occurance of a 60 day late payment, etc. Were there accounts that went into collections or written off to a loss (charged off). Is there a bankruptcy, judgements, or other public records, such as tax liens reporting.

Amounts Owed: 30%
Owing a lot of money on many accounts can indicate the borrower is over-extended. However, having no accounts, or no payments history makes it difficult to assess the borrower's ability to repay. Also taken into account is the percentage of monies borrowed against how much credit line is available.

Length of Credit History: 15%
Generally, a longer credit history will increase the score. It gives a better picture as to the historical pattern of the borrower.

New Credit: 10%
Any time a lender pulls a copy of a credit report, they show up on the report as an "inquiry." A borrower shopping for a good car loan may have their application presented to several lenders within a short period of time, presumably shopping for the best loan. Generally, inquiries that occur within a 14 day period are treated as a single inquiry. Inquiries indicate to the lender that the borrower is taking on new credit obligations, impacting their ability to pay in the future. Therefore, opening several accounts over a short period of time can have an impact on the FICO score.

Type of Credit n Use: 10%
The score considers the mix of credit cards, retail accounts, installment loans, mortgage loans, etc.

What Is Not Included in a FICO Score

• Race, color, religion, national origin, sex and marital status.
• Age
• Salary, occupation, title, employer, date employed or employment history
• Location of residence
• Interest rate being charged
• Any items reported as child/family support obligations or rental agreements
• Certain types of inquiries
  • Consumer-initiated
  • Promotional inquiries - made by lenders offering "pre-approved" credit
  • Administrative inquiries - reviewed by current lenders to review status, or coming from employer inquiries
• Any information not found on the credit report
• Any information that is not proven to be predictive of future payment performance
• Whether the borrower is in a credit counseling services. (Top of page)

Lenders View Risk

Lenders do not rely solely on the FICO scores to make a credit risk determination. Here is a general breakdown, however it is important to note that there is no single cut-off score. Each lender has its own score criterea, as well as various other aspects of the credit review which are used to determine the overall credit risk.

650 and Above
In general, a score of 650 or above indicates a very good credit history. People with these scores will usually find the loan process quick and easy, and will have a good chance to obtain a loan at a relatively low rate of interest.

620 to 650
Scores between 620 and 650 indicate basically good credit, but also suggest to lenders that they should look at the potential borrower to asses any particular credit risks. (Average FICO scores fall into this range.) People with scores in this range have a good chance at a loan at a good rate, but may have to provide additional documentation and explanations to the lender before the loan is approved. This means that their loan closing may take longer, making their experience more like that of borrowers in the days before credit scoring, when every individual was researched.

Below 620
A score below 620 may prevent a borrower from getting the best interest rates, as they may be considered a greater credit risk-but it does not mean that mortgage funding can't be found. The process will probably be lengthier and, as noted, the terms of loan less appealing, but often a loan can still be obtained.

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Alternative Credit

Some loan programs, like FHA loans for example, will look at alternate credit to make decisions concerning credit worthiness. An applicant may not have established credit yet, or what credit had been established is too old. Ratings can instead be given from utility companies, phone companies, even from the health club.

Other Credit Factors Lenders Consider

• Bankrputcy ~ Lenders vary according to their requirements. Some lenders will not extend a loan to any applicant who had a bankruptcy discharged within the last 3 years. Most lenders use a 2 year guideline. There are a number of lenders who will lend to applicants who have a bankruptcy discharged within the prior 2 years, however they lower the amount they will lend against the property with an increased interest rate. There are even a few lenders who do not have an interest in prior bankruptcy and use other grading criterea to base their lending guidelines (ie. recent mortgage or rental payments)
• Mortgage or Rental payment history ~ Generally lenders seperate the FICO score from the mortgage or rental payment hisotry (usually over the past year). Therefore, an applicant with an 800 credit score, but who hasn't been paying their rent in a timely manner for the past year, or can't document a payment history, is considered to be a higher risk, despite the high FICO score. Documenation of payments can be through the credit report, a property management company (not a private party), or 12 months of canceled checks.
• Collections or Judgements ~ The lenders that offer the lowest interest rates, typically require collections or judgements to be paid in full as part of the approval requirements. Lenders who do not require them to be paid, typically offer a higher interest rate to compensate for the higher risk. (Top of page)

Credit Agencies

Here is a listing of the three main credit bureaus.

Equifax: www.equifax.com
Equifax Credit Information Services, Inc
P.O. Box 740241
Atlanta, GA 30374

Trans Union ~ www.transunion.com
PO Box 949
Allen, TX 75002
(800) 831-5614

Experian ~ www.experian.com


Additional Links
Credit Advice provided by Experian
Managing Personal Credit ~ Trans Union
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