Better Understanding Of How Credit Works

Having good credit scores and FICO scores not only help buy a home, but they help you get better rates on your credit cards, your car loans, and your insurance rates.

Credit is nothing more than a look at how you’ve paid your debts in the past, and manage your debts, as a prediction of how you will handle them in the future. It can be an indication of your character in regards living up to the promises and agreements you have made to repay debt. You can have a lot of money in the bank, but it does not affect your score because money in an account does not say how you repay your debt.

So, What Do Underwriters Are Looking For And Wanting To Know?

Obviously when underwriting a loan, they want to know if you will repay. Credit is not good or bad. And it doesn’t say how good you are at managing money. What credit does is tell how well you are at paying back your debts, using one specific number.

Often people will say, “Well, I’m not going to default on my loan. I’m living there.”

Well, these FICO scores and ranges have been determined by history of performance on loans at different score levels of hundreds of thousands of people

What the trends tend to be, and at what levels do people start getting in trouble with credit and managing credit?

Typical Mortgage Credit Scores

The full range for FICO Scores is 300-850.
Typically, with mortgages, you can get them down as low as in the mid 500's, but 98% of all the mortgages start at about 620 and above.

Rates on loans below 620 are available. The rates are very high and you need to have several other offsetting benefits like a lot of money in the bank for example to offset the score. Usually, it is easier and better to increase the scores to 620 and above.

As your score increases above that the risk is perceived as less so the rates charged improves

Once you get to 640 and above, your rates get better. Once you get above 680 rates even better and 720, they get even better. And then if you’re up near 800, your interest rates get better, because it’s perceived as less risk.

What Credit FICO Score Is Made Up Off

Payment History (35%)
On your existing credit you have, are you paying as agreed? Are you paying on time?
Your payment history is the biggest factor in determining your credit score, so it's imperative that you pay your bills on time whenever possible. If you have late pays on other accounts why would a mortgage lender want to lend you hundreds of thousands of dollars for a very long time period if you are not paying your existing debts on time. So pay on time.

If you’re behind, bring the accounts current and pay as agreed. If you do make a late payment, there are three factors that determine how much it will affect your credit score – your credit score and credit history.

How long ago was the late payment? How severe the late payment was?

According to FICO's credit damage data, one recent late payment can cause as much as a 180-point drop on a FICO, +0.85% score, depending on your credit history and the severity of the late payment.

Amounts Owed (30%) Also Known As Capacity

Another section of your score will be capacity. Are you maxing out? Because the reason they see people get into trouble is when they pull up a lot of credit, they are living at the very peak of what they can borrow, which means they’re living on credit, and not managing very well.

What you want to do, is have your cards, let’s say you have three cards, and each one is $5000. If you have each one borrowed up to $5,000, that’s not good. You’re at max capacity. Or if each one is at $4,000 you are at 80% capacity.

What you want to do is get down below 30%.

So if it’s $5,000, that’d be $1500 per card.

And if you can get it down to 15% or 10%, that’s even better.

That means you have plenty of capacity, and you’re managing your debt well, and you’re not living off debt day to day. That will help your score tremendously.
So one of the fastest things you can do to raise your credit scores is get your capacity improved.

Length of Credit History (15%)

The “length of credit history” means how long any given account has been reported open, says Rod Griffin, director of public education for Experian. "Generally, the longer an account has been open and active, the better it is for the credit score,” Griffin says. “That's particularly true for an account with a positive payment history that has no delinquency."

The credit scoring algorithms calculate the average of how long all your accounts have been open. That average age of accounts is your "credit age."
It's all but impossible to get a score higher than 800 if you're young, because your credit age likely will be less than that of a person who has had credit for years.

It takes time

It is also why not to close accounts.

Keep them open and keep small balances paying them on time.

New credit (10%) credit pulls indicate possible new credit

What they are looking at is, are you getting a lot of new credit lines?

Will those lines be fixed and on an asset that can increase in value like a home? Or will it be on cars that depreciate?

Or lines of credit like credit cards that you can keep spending on, meaning you may be living on credit to get by?

Credit mix (10%)

Same is true on your existing credit – what type of lines do you have?

Will those lines be fixed and on an asset that can increase in value like a home?

Or will it be on cars that depreciate?

Or lines of credit like credit cards that you can keep spending on, meaning you may be living on credit to get by?

Will Having Your Credit Pulled Hurt Your Credit Score?

People keep thinking, “Well, if I get my credit pulled, it’s going to ding my credit.” No, typically you have 30 to 45 days, and it’s only going to hit your initial pull, and you can have multiple pulls in 30 days, and it does not affect your credit.

Initial pull of a report is only about 5 points.

If you need a loan, do your rate shopping within a focused period such as 30 days. FICO Scores distinguish between a search for a single loan and a search for many new credit lines, in part by the length of time over which the inquiries occur.

While inquiries often can play a part in assessing risk, they play a minor part in only 10% of what makes up a FICO Score. Much more important factors for your scores are how timely you pay your bills and your overall debt burden as indicated on your credit report.

Inquiries can have a greater impact if you have few accounts or a short credit history. Large numbers of inquiries for multiple lines of credit like credit cards can also mean greater risk.

Statistically, people with six inquiries or more on their credit reports for credit lines and credit cards are up to eight times more likely to declare bankruptcy than people with no inquiries on their reports.

This is different from someone having pulls on the one mortgage they are getting.

What lenders will want to know is if you’ve had multiple pulls, is why? And you will only probably need to write a letter of explanation that you were shopping for loans, and that you had no intention of borrowing money towards down payments. And you have no other loan applications that you plan to close on

To Improve Capacity
Now there’s a couple of tricks to this.

One, you can pay it down.

You could, the other is, you can ask some of the credit cards that you have, if they will increase your limits? So in other words, your capacity would go up, but you don’t want to borrow on that capacity.

Now, the other thing that people do is they say, “Well, I’m just going to go pay it off."

Do not pay off your cards. Here’s why.

You want to get them down very low, keep $5 to $10 on there. That’ll keep the capacity there, and you’ll pay on time for a long time period.

If you take a card you’ve had for several years and close it down, not only does that time history go away, and impact you, but you’ve lost capacity.

On the other hand, using a low percentage of your available credit can have a positive impact. In some cases, a low credit utilization ratio will have a more positive impact on your FICO Scores than not using any of your available credit at all.

Not A Magic Wand
When looking at your credit report, you want to look at what’s negative, and what’s positive

It has been estimated that 20% or the reports are wrong or have wrong information on them. According to a study conducted by the Federal Trade Commission, one in five people have an error on at least one of their credit reports.

The good news?

You can get a free copy of your credit report every 12 months from each of the three major credit reporting companies at AnnualCreditReport.com. You can request all three reports at once or request one every few months to review your information throughout the year. And if you find errors, you can dispute the errors at no cost to you with both the credit reporting company and the company that provided the incorrect information.

Get A Copy Of Your Report

You can request and review your free report through one of the following ways:

Online: Visit AnnualCreditReport.com
Phone: Call (877) 322-8228
Mail: Download and complete the Annual Credit Report Request form. Mail the completed form to:

Annual Credit Report Request Service
P.O. Box 105281
Atlanta, GA 30348-5281

Reviewing your credit report
Once you get your credit reports, you'll want to review them carefully. You can use the list below to check for common errors and make sure your credit reports are accurate and up-to-date. Each of the credit reporting companies may have different information in your credit report - that's why you should request your report from each of them.

Personal information

• Errors in your identity data, such as wrong name, phone number, or address
• Accounts belonging to another person with the same or similar name to you
• Incorrect accounts resulting from identity theft

Reporting of account status

• Closed accounts reported as open
• You're reported as the owner of the account, when you're just an authorized user
• Accounts that appear multiple times with different creditors listed
• Incorrect date of last payment, date opened, or date of first delinquency
• Same debt listed more than once

Balance errors

• Accounts with incorrect current balance
• Accounts with incorrect credit limit

Data management errors

• Reinsertion of incorrect information after it was corrected
• Accounts that appear multiple times with different creditors listed

Medical Debts
Medical debts are removed once paid: While most collections remain on your credit report for seven years, medical debt is removed once it has been paid or is being paid by insurance. Unpaid medical debt in collections will still remain on your credit report for seven years from the original delinquency date.

The Consumer Protection Financial Bureau (CFPB) found that millions of consumers only have medical collection debt on their credit report. Most of those consumers are in their prime home buying years, between age 24-46.

Because those consumers are less likely to default on future credit accounts than those with non-medical collections, FICO credit scoring, Fannie Mae, Freddie Mac and FHA now treat medical debt differently, which should increase the number of mortgage approvals for these consumers.

Tips For Dealing With Collections

Sometimes people have collections on their report. Usually, most loan investors are going to require you to pay them off

Now, if you want it off your report - a credit improvement advisor is recommended. You can pay it off, but that will not mean it is coming off the report. We suggest if you are doing this yourself you call the company. Do not tell them you are buying a home - you will lose your leverage. Tell them you will pay it off if they are willing to remove it. Often they will!

Have them send you a note saying they will remove it if paid. Do not just take their word for it because once you paid it off they have no reason to work with you on it.

Credit Repair and Improvement

Now, often people say, “Do I need a credit repair company?

Well, there’s many of them out there. You can even do this on your own.

A lot of them charge you money every single month, just to get a fee. And all they’re doing is sending out a cookie cutter standard letter, and they bombard the three repositories with letters.

If you want, you can go to the CFPB and here’s the link, which is a guide to credit rebuild, and you can do it yourself : How to rebuild your credit

I also have two repair firms that I use and they are quite reputable, and they do a great job.

If you have some negative history and you put a plan together whether you do it yourself or get someone to help you, you’ll be amazed how fast your credit can go several points.

Conclusion

Credit repair and improving your credit is not waving a magic wand, even though I’ve seen some remarkable things happen. It takes effort and taking the right steps.

Lakeway Lending is the best mortgage broker in Austin, Texas, who can help you find the right home for you. With services in mortgage loans, property evaluations, and other real estate purchasing areas, you won’t find better loan procedures anywhere else. Get in touch with us today to be one step closer to your dream home.