Know the score

Learning about credit scores can help you better serve buyers.

by Marty Kramer   If you could give a homebuyer some advice that helped him save $44, do you think you would have a client for life? What if your help saved that person $44 every month he owned his home?

Here’s how this hypothetical situation plays out. A buyer comes to you well before he plans to purchase a home; you show him how to access his credit score. You explain what the score is, how lenders use it, what factors affect it, and give him some ideas and resources for improving it. Which, over time, he does. When he’s ready to buy a home, he secures a loan a little more than half of a percentage point lower than he would have before his credit-score makeover. That translates to $44 every month on his $150,000 loan, or about $16,000 over 30 years.

While these exact circumstances may not present themselves to you, credit scores certainly can influence a buyer’s mortgage rate and even ability to qualify for a mortgage. Buyers with low credit scores also may be required to make larger down payments. Your knowledge of how these consumer credit ratings work can enhance your service to buyer clients.

What is a credit score?

A credit score is a numerical rating that attempts to measure a borrower’s creditworthiness. A high credit score does not guarantee that a loan applicant will never default on a mortgage; however, that person represents a statistically smaller risk than a person with a low score. Lenders, therefore, are more likely to approve loans and offer their most-favorable terms to people with the highest scores.

Credit scores have been used for 30 years by lenders to decide whether to offer consumers credit cards and car loans. Credit scoring to rate mortgage applicants has been used extensively now for about eight years.

Many companies provide credit scores. Fair, Isaac & Co. furnishes the most commonly used rating: the FICO score. Though all three major credit bureaus—Equifax, Experian, and TransUnion—provide FICO scores to creditors, an individual’s score may differ slightly from one bureau to another. That’s because the score is developed only from the credit information on file at each particular bureau, and information may vary from one to the next.

Once a secret shared between credit-reporting agencies and lenders, the scores are now out there for all borrowers to see. Well, purchase, actually. For $12.95, anyone can take a look at their FICO score, the measure that three-fourths of mortgage providers use to help predict a homebuyer’s creditworthiness.

Scores are determined by weighing several factors in a person’s credit record, including payment history, balances, number and types of credit accounts. By using a formula, results can be more objective than humans relying on different criteria to create a measurement. Credit scores do not consider a borrower’s race, gender, religion, age, income, marital status, or national origin. But mathematical formulas have limitations. For example, a person who has always paid cash for purchases will score low due to a lack of credit history. Many lenders, therefore, do not rely exclusively on a credit score and will take other factors into account that may mitigate a poor credit score.

What factors go into the credit-score formula?

Though the breakdowns can change depending on an individual’s history, generally, 35% of a FICO score is derived from a consumer’s payment history. That is, do you pay credit cards, mortgage, and car-loan payments on time, and is your history free from bankruptcies, foreclosures, wage attachments, liens, etc.? As you might imagine, the more recent and larger a negative item, the farther it drags your score down. Also, the more instances you have of a problem, the lower goes your score.

Amounts owed makes up another 30% of FICO scores. The total amount owed, whether you are close to the maximum amount on credit cards, how many accounts you have, and what balances remain on installment loans all come into play in this area. The Fair, Isaac & Co. consumer Web site, MyFico.com, notes that a small balance on a credit card with on-time payments may be better than carrying no balance.

About 15% of the score comes from the length of your credit history, including how long specific accounts have been established and the length of time since you used specific accounts. Another 10% of the score is determined by how many new accounts and requests for credit you have. The overall makeup of your credit determines the final 10% of your credit score.

What is a good score?

FICO scores range from 300-850. The lower the score, the higher the credit risk. While no industry standard exists for making decisions based on scores, most lenders will look favorably on a score in the 700s or above. Approximately 60% of U.S. consumers have FICO scores higher than 700. According to Fair, Isaac & Co., borrowers in the 700-749 range have a credit delinquency rate of 5% (on all types of credit).

Most other companies’ credit-scoring models employ similar scoring systems.

Get some first-hand insight

One way to gain insight into credit scores is to obtain yours. You will better understand the process and see what kind of information is available to consumers. As a bonus, you get to peek at your current credit rating and credit report, something the experts say you should do at least once a year.

To access your FICO score, visit MyFico.com or Equifax.com. After submitting your personal information—including answering questions about loan balances and names of lenders intended to screen out unauthorized users—you will receive your score (850, no doubt). You also get a summary of how your score likely will be judged by lenders, a graph of how many borrowers have scores above and below yours, and, perhaps of most use, a summary of the positive and negative factors affecting your score. You can view your full Equifax credit report—a list of account activity from your credit cards, mortgages, car loans, and other credit history. The credit score remains accessible online for a month. Any changes to your credit report will change your credit score during that time. However, the score that you access during that month does not change.

MyFico.com provides an online calculator, so you can run simulations to determine how specific actions, such as paying off a credit card, will affect your score.

Credit reports and scores are also available from the other two major credit bureaus: Experian and TransUnion. However, scores provided to consumers by these bureaus are not FICO scores.

Another option is to visit E-Loan (ELoan.com) for a free credit score, furnished by CreditXpert. This score does not come with a credit report, but it does give you a glance at how your creditworthiness may be viewed by a lender.

Once you understand what goes into the credit-scoring process, you will be able to use your knowledge and tap into resources to help turn buyers into something else: homeowners.

Photo illustration by Joel Mathews; photos © PhotoDisc.

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