Mortgage Finance
Help Buyers Understand Credit Scoring
The more you know about credit scoring--the way many lenders now qualify mortgage applicants--the more value you can bring to homebuyers at the margin.
By Jerry DeMuth
Credit scoring--assigning numerical ratings to consumers on the basis of their credit history--has been used for more than 30 years by auto lenders, credit card issuers, and other extenders of consumer credit. Now it’s being used to determine whether your homebuyers qualify for mortgages.
Some say credit scoring widens the market and helps more people get a mortgage by removing human biases from the approval process. It also offers flexibility for buyers who are pushing the standard debt ratios but have proved their ability to handle the debt. Detractors argue that the approach pushes some buyers into higher interest rates or out of the homebuying market completely.
Whatever you think of credit scoring, it’s probably affecting your business. Fannie Mae and Freddie Mac, which, in an average year, purchase about 58 percent of all residential conforming mortgages, began in mid-1995 to encourage or recommend the use of credit scores by lenders. Then both the agencies introduced automated underwriting systems for lenders that include credit scoring.
By getting up to speed on how credit scoring works, you can help buyers--particularly those who are at the margin in terms of qualifying--get through this mortgage finance hurdle. To help you better understand lenders’ use of credit scoring in their underwriting decisions, NAR recently worked with Freddie Mac to produce educational materials on the topic. You can download Doorway to Good Credit—a booklet for real estate practitioners and an accompanying consumer brochure--from One Realtor Place® (see “Online” box).
Scoring ins and outs
“Before, qualifying for a mortgage was as simple as paying your bills on time for two years, not paying more than 28 percent of your monthly income for housing and no more than 36 percent for other debts,” observes Debbie Delwiche, a loan officer with Bank One Mortgage Corp., Janesville, Wis. Delwiche is a licensed REALTOR® and past chair of NAR’s Conventional Finance and Lending Committee. “It’s not that simple anymore.”
Credit scoring uses reports from any of the three major credit repositories--Equifax, Experian, and Trans Union--to grade consumers on a 900-point scale. The scores are calculated by the credit bureaus, not by lenders. The credit score isn’t a permanent part of any credit history but rather a snapshot of a mortgage applicant’s credit history.
Fannie Mae recommends that lenders do comprehensive reviews of borrowers with scores between 620 and 660. If the score is lower than 620--as low as 585--the downpayment should be at least 30 percent in order for borrowers to qualify for a conventional mortgage, according to Robert Engelstad, Fannie Mae senior vice president for mortgage and lender standards.
Those not qualifying may have to turn to subprime mortgages, which carry rates one-quarter to 2 percentage points higher than prime or conventional mortgages. The fees and closing costs are also higher.
How the math works
Both Freddie Mac and Fannie Mae tell lenders that loans should be neither approved nor rejected on the basis of credit scores alone, but many lenders say they fear they won’t be able to sell loans to either agency if scores are below 620.
The more than 100 variables used in credit scoring include the following:
- Existing credit cards
- Other open or active accounts, their type, the length of time credit has been available, and credit levels
- Current level of indebtedness and its relation to available credit
- Outstanding auto loans and other loans
- Credit performance, including the number and severity of late payments and delinquencies
- Number of inquiries or attempts to acquire additional credit, especially in recent months
The object is to establish a weighted numerical measurement that reflects a borrower’s likelihood of repaying the mortgage loan on time--the borrower’s default risk.
Every scoring model uses the same data to establish a score, but the weight attached to each component of the score is different with each model. It’s this weighting that the developers of each model carefully guard, even going as far as not wanting lenders to reveal the scores, says Delwiche.
Clean credit pays off
That doesn’t mean consumers shouldn’t understand the process of scoring, though.
“Consumers need to be educated about what’s going to impact their credit scores,” says Jeannette Way, a practitioner with Coldwell Banker-North Bay Realty, Vacaville, Calif., and the 1999 chair of NAR’s Conventional Finance and Lending Committee. “You have to tell buyers to do nothing that will lower a credit score before they get a mortgage.” (For more tips on helping your prospects keep a clean credit report, see “ Say no to new credit.”)
According to Janice Daue, a Fannie Mae spokesperson, “Having established credit, paying your bills on time, and keeping the balances on open accounts to moderate levels help ensure that you have a strong credit history and a good score.”
Way also suggests counseling consumers to take a look at their credit reports early on and not get new credit cards. “And don’t shop and buy for the home before the loan closing,” she says. “Buyers can go and look, but they can’t let stores run credit inquiries.”
Secret scores?
Delwiche says NAR sees three potential problems with the use of credit scoring:
1. The weighting of the data used in determining a score is guarded on proprietary grounds.
2. Credit bureaus are often slow to record that outstanding loans--particularly student loans--have been paid off, increasing the likelihood that scores are based on inaccurate information. Delwiche says she’s seen credit issues that had been resolved two or three years earlier still impacting scores. “How long before you can pull your score up to an acceptable level is still a true unknown,” she charges.
3. Many prospective borrowers never learn their score because many lenders won’t reveal scores. The decision whether to share credit scores with borrowers is up to the lender, says Fannie Mae’s Daue.
“Finding an open lender that’ll play it straight is the key to filling buyers’ needs,” stresses Sue Wiskowski of Realty Executives, Aurora, Ill., vice chair of NAR’s Conventional Finance and Lending Committee.
Step one: read the credit report
Each of the three major credit repositories--Equifax, Experian, and Trans Union--has its own proprietary credit scoring model, Beacon, FICO, and Empirica, respectively.
Before buyers shop for a loan, experts recommend that they check their credit report. Some states require that credit repositories provide consumers with at least one copy of a credit report annually at little or no cost.
Buyers can get copies of their reports from each credit repository. Here’s how to reach them:
- Equifax: 800/685-1111;equifax.com
- Experian: 800/682-7654; experian.com
- Trans Union Corp.: 800/916-8800;tuc.com
Sayno to new credit
To help buyers attain the best possible credit score, advise them to avoid any behavior that’ll negatively impact their credit scores before their loan closing.
Here are some expert tips you can pass on to them:
- Don’t order any furniture or appliances for a new home even if no payment is immediately due, such as the no-payment-till-spring deals.
- Don’t let any stores run a credit check for a new credit card when you’re shopping or looking for new furniture or appliances.
- Don’t get new credit cards, even when stores offer a discount in return for applying for a card.
- Pay all credit card bills on time, even if it means paying utility bills late.
- Refuse increases in your credit limit if the increase is more than you need or is high in relation to your income.
- Pay off and close any existing accounts with finance companies, since they’re viewed negatively in the scoring.
- Close out unused credit card accounts.
- Maintain at least one of your oldest cards to show a lengthy credit history.
ONLINE
Answers to your credit scoring questions . . . NAR, with Freddie Mac, has developed educational materials--Doorway to Good Credit--to address questions from real estate professionals and consumers about credit scoring. To download the consumer brochure or the booklet for real estate practitioners, search “credit scoring” at One Realtor Place® at REALTOR.COM.
