By JoAnn Sworan
In today’s lending environment, it’s more important than ever for Buyer’s Reps and their clients to address credit scores at the earliest opportunity. As a rule, lenders are looking for FICO scores over 650 and the best interest rates are reserved for the buyers above 760. Just one 30-day late payment can throw a score off by as much as 50 points.
Aggravating the situation, nearly 80 percent of all credit reports have errors. Consumers are responsible for finding any mistakes and disputing them with credit reporting agencies.
That’s why I encourage buyers to investigate their credit score at least six months before they plan to purchase a home. This provides time to fix potential errors and/or make strategic decisions about the best way to improve a bad credit report.
Credit Score Components
At its core, a credit score is a number that represents a person’s credit worthiness. It illustrates patterns in a consumer’s past spending and borrowing behavior, and helps banks and other lenders gauge whether it’s safe to extend additional credit, especially for mortgages, typically a consumer’s largest purchase.
A buyer’s payment history comprises the biggest part of their credit score (35 percent). But it’s not the only piecof the puzzle. The amounts currently owed play a big role (30 percent), and other factors can also drive a score up or down.
The amount a consumer owes is viewed in relative, rather than absolute, terms. For example, if someone has four credit cards all approaching their limit, they will be viewed unfavorably compared to an “identical” comsumer who owes the same amount of money, but is only using 25% of their total credit line.
This concept is termed credit utilization (CU). Specifically, CU is defined as a borrower’s outstanding balance divided by their credit limit. Typically, the algorithm is looking for a CU below 30%; less than 15% is considered ideal.
Hard Versus Soft Credit Inquiries
Consumers are entitled to a free copy of their credit report once a year, available through sites like creditkeeper.com, annualcreditreport.com or identityguard.com. While the credit report from annualcreditreport.com is free, it doesn’t include a credit score. For this, consumers must pay a nominal fee.
When a consumer asks about their own credit score, it’s considered a “soft inquiry”, which doesn’t impact their FICO score. Credit card, insurance companies, banks and others can also make soft inquiries, in order to identify consumers for marketing purposes. In contrast, “hard inquiries” for a consumer’s credit history are made if you apply for a loan, a mortgage, or open a new credit card. Depending on other factors, too many hard inquiries could have a negative impact on a consumer’s FICO score.
Five Common Mistakes
1. Closing old accounts.
Since 15 percent of a consumer’s credit score is based on the length of their credit history, closing old accounts that are no longer used can actually hurt your credit score. Old, even inactive lines of credit can tell a positive story about someone’s past history. They can also improve your credit utilization ratio by contributing to the total amount you are allowed to borrow.
2. Paying off old debt.
Assume that a consumer discovers some small balance on an old account they don’t recognize or remember. Don’t make the mistake of simply paying off the balance, assuming this will clean up a credit blemish. Paying old debt will update the date of last activity. This may cause a decrease in the score.
Instead, a consumer’s first step should be to verify that the debt is legitimate. if so, pay it right away; if not, take steps to have the charge removed. It’s also possible that the charge is so old that it has passed the statute of limitations, which varies by state.
3. Opening new lines of credit.
While it may be tempting to accept a retailer’s offer of free financing on the new refrigerator, washer and dryer a buyer needs for their home, they should wait until after closing day. In fact, buyers need to avoid any actions that alter their credit picture after they’ve applied for a mortgage but before the transaction has closed. Even pre-approved buyers are subject to a lender’s second review of their credit score prior to closing. Our recommendation is to watch activity on all revolving and installment accounts six to 12 months prior to buying or refinancing a home.
4. Assuming you know your credit score.
Each credit bureau and related credit-reporting company uses their own algorithm to establish a credit score. As a result, a consumer’s so-called soft inquiry can generate a different number than the actual FICO score a mortgage lender sees.
5. Credit line increases / decreases.
If a credit card company raises their credit line with a consumer, that consumer’s CU ratio just improved. But keep in mind a creditor also has the power to lower a credit line if they see too much activity over long periods of time or missed payments on another creditor’s file. This can drastically change your score by as much as 100 points!
Credit Repair Solutions
These are just a few of the most common mistakes. If a prospective home buyer’s credit score needs improving, they’ll make smarter decisions and get better results if they work with a professional credit repair specialist.