Inside The Mortgage Machine pt. 2 – Credit Scores & What to Do
This is part of an on-going Lending Comprehension Series. Part 1 can be found here.
We all know that your credit score is one of the biggest factors that determines your available mortgage rate and terms. Your credit score can range from 350–850. There are many factors that are calculated when compiling your three digit ability to purchase a home, car, or toaster. While the formula is so complex that even the folks at Fair Isaac & Co (the company who developed the almost universal calculation scheme) probably don’t understand it all, there are some things that we mortgage professionals have come to understand. I’d like to share them with you in hopes that you can build (or repair) your personal score in time to still get a great deal on some real estate before you miss the next wave of appreciation.
1. Credit history
This part refers to how long you’ve had established credit. Did you know that having a credit card that is 2 or more years old (and well managed) is better for your score than a brand new one? If you’re looking at getting into a mortgage and someone tells you they think you have too many credit cards & you should cancel some of them, the worst thing you can do is keep those new ones with ‘teaser’ 1st year rates and cut up the oldest ones you’ve got? The reason is this, part of the formula looks at how long you’ve had established trade lines. If you’ve had a few cards for a few years and still manage them well, you’re a much safer lending risk.
2. Credit depth
This refers to the different sort of credit you’ve been extended. Credit cards, or what’s known as ‘Revolving Trade lines are only one such type. You’ve also got what are know as ‘Installment Loans.’ Rather than a revolving credit where you can borrow, pay down, turn around & borrow again; Installment Loans are lent in one big installment and paid down over time. A good example of an installment loan would be a car loan. Having about three or four well managed revolving accounts and one installment loan on your credit report is a good start in developing credit depth, which will raise your score.
Of course, what is usually the biggest loan, and which you get big ups from the lenders for acquiring and managing well is your mortgage loan. In an ideal world you’ll want to get your credit cards first, your installment loan second, and your mortgage loan third because they are usually increasingly large amounts, and having each prior category well managed will save you money on the next tier of credit extension. (with all that money you save you can pay down your debt, right?)
Mortgage lenders like it best when you have a combination of at least 3 or 4 trade lines, with some variety as to the type of credit. This doesn’t mean if you’ve never had a credit card or car loan we can’t finance your home. Some lenders I broker home loans to will accept an alternative trade line. This could be your power bill, cell phone bill, etc. re-structured to report on your credit report.
3. Balance to Limit Ratios
If you’ve ever looked a through copy of your credit report, you’ll notice two of many very important numbers. Number one is how much total debt you can rack up on your credit card. Number two is how much you have racked up on that card. While having large amounts available to you is good, what is more important is the percentage of that amount you currently have used. You will notice the best increases in your credit rating if you can keep the revolving accounts balances at or below 30% of their total limits. We understand life happens and emergencies can cause you to go over this amount. Don’t freak out. If you can maintain even a 50% or less Balance to Limit Ratio, you’re still doing good, but 30% is still what you should aim for.
4. Frequency of Use
So you want a few credit cards. But just applying for 200 cards and throwing them in a drawer thinking they’ll do great things for you is not going to help. (please note I’m being sarcastic here, DO NOT go apply for 200 credit cards) A FEW, maybe 4 or 5 max is a good number for most people. But now that you’ve got them, you’ll want to use each one at least once a month & then pay it off, ideally before, but certainly not after the balance is due. Showing the credit bureaus that you are using and responsibly managing your trade lines will raise your score.
Let me make a side note here. There are two types of revolving credit card accounts. Despite all their great marketing campaigns, Capital One does not keep money in your wallet. They keep money in their wallet. How? Remember what we said about your balance to limit ratios? Well certain companies *cough, capital one, orchard bank* don’t report ANY LIMIT. Sounds great, right? The credit bureaus will think you have unlimited credit! Woo Hoo! Nope, sorry, credit bureaus don’t usually take the ideal side of the consumer. They’ll look at your $1.00 Capital One balance & your lack of a limit & assume you have a credit card with a $1.00 limit, and you’re maxed out! When you apply for a credit card, ASK “is this an R1 or an R2 rated account?” If they tell you it’s and R2 account, tell them to have a nice day. R1 accounts help your credit, and R2 accounts keep you in the credit trenches, therefore they’ll be the only ones willing to offer you credit, and they can play around with your interest rate once you’ve got too much racked up to get out.
Because you also need credit HISTORY, if you’ve had nothing but a Capital One & Orchard Bank card for the last 4 years, DON’T cancel them! Here’s the trick. Pay them down to zero, leave them open, buy 1 tank of gas on each one every month pay it back the next day. That way you’ve got your bases covered. You’ve maintained your history, you’ve got your balance to limit ratios in line, and your zero balance will negate any possibility of looking ‘maxed out.’ After managing those as such, PLEASE go get yourself a good credit card. Cards through brick & mortar banks are usually good (Bank of America, Wells Fargo, Citi), but that’s the last time I’ll tell you to go to a bank for credit, I can usually blow them out of the water on Mortgage rate & terms!
5. PAYMENT HISTORY.
There’s a reason this one’s in all caps. It’s freakin’ important! If you lend a friend $200 dollars and never see it again (or them) would you do the same next time they call crying? Didn’t think so. Please pay your bills. It’s better to make all your payments on time, even if it’s just the minimum, than to get all excited about paying down one card while the others go 30,60, or 90 days behind. Those show up as swollen slaps on the wrist in your report. And please above all, pay your mortgage! Mortgage lates are a whole other criteria to lenders. Since that’s the business they’re in, you can have a great FICO score, but somehow have more than 3 mortgage lates & run into issues, if this is the case I’ll fight for you, but YOU still need to show that you’re a reformed borrower and now understand the way of things.
6. Other Items You Might Not Consider
Judgments Unpaid, Tax Liens, and Medical Collections can also seriously bring you down. While I encourage responsibility on the Judgments, & Tax Liens I have credit repair people you can speak with that can take any medical collections off your credit report pretty quick. If you need a referral to a good credit repair company, or have questions about your personal situation, please call me directly at 702–686–2036. There are many shady ‘credit repair’ companies in Nevada that would love to promise you the FICO world, rape your pocket book & leave you hanging. There are a few reputable, efficient ones & Emerald Pacific’s got you covered should you need a reference.
There will be more to come in this ongoing series. To read the first post on the Mortgage Machine, ‘What Determines My Mortgage Rate?’ Click here.