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Shopping for a mortgage: credit score more important than ever

Posted by  on Dec 13, 2010
 

Ironically, just as credit scores are reportedly becoming more important than ever in deciding whether to approve a mortgage application, average American credit scores have dropped across the board. In fact, according to credit scoring firm FICO, 25 percent of all consumers now have scores of 599 or lower, which means they are virtually unapprovable for mortgages. Historically the rate of people with scores of 599 or lower has been around 15 percent. Only about 30 percent have credit scores of 650 or higher, which is high enough to get most people approved to purchase homes or refinance mortgages if they have at least 20 percent down payment or home equitys

Why credit scores are poor predictors of mortgage success

Fannie Mae and Freddie Mac, for example, will lend to someone with a 620 credit score (although they would probably require lots of compensating factors like big income, significant assets, and a whopping down payment) but they absolutely won't touch someone with a 619 score. So is there that much of a difference in the person with 619 as opposed to the one with 620? Is the scoring that precise? Of course not.

Consider the information that goes into the algorithm that creates the score. Nearly all credit reports contain errors. Lenders aren't required to submit information, and it's only as accurate as their own files. Some of them update accounts immediately, some take months, and some don't do it at all. Some lenders are accurate, others are sloppy. One data entry error affecting current balance or payment history can strip a hundred points off your credit score.

Your credit report is only a snapshot

In addition, credit bureaus can't tell if your credit is improving or getting worse. That would be a pretty important piece of information for those making credit decisions, but it's not available. If bureaus would capture your scores quarterly and report them, underwriters could see if you are heading in the right direction or down the wrong road.

Finally, mortgage experts don't agree that FICO scores predict foreclosure. The amount of home equity, borrower's debt-to-income ratio, job stability, and cash reserves are all better predictors than credit scores, according to industry insiders like Dave Zitting, chief executive of Primary Residential Mortgage Inc., a nationwide lender. And yet, says Zitting, "The credit score has become the line in the sand for the banks."

What can you do?

Unfortunately, the burden is on you, the borrower, to examine your credit reports carefully, spot errors and get them corrected. That's why the bureaus are less than vigilant about it. It also behooves you to know all three of your credit scores (lenders take either the lowest of two or the middle of three) so that you know what you're getting into when you apply for a mortgage.

A real-life example

Here is a snapshot of a recent Fannie Mae Loan Level Pricing Adjustment (LLPA) matrix, which gives the prescribed loan rate increase according to credit score and loan-to-value (LTV) range. You can see how a small change in credit score affects the best mortgage rates you'll be offered.

 

LLPA if LTV is:

 

 

 

 

 

 

 

Credit Score

60 pct or less

60.01-70 pct

70.01-75 pct

75.01-80 pct

80.01-85 pct

85.01-90 pct

90.01-95 pct

95.01-97 pct

>739

-0.25

0

0

0

0

0

0

0

720-739

-0.25

0

0

0.25

0

0

0

0

700-719

0

0.5

0.5

0.75

0.5

0.5

0.5

0.5

680-699

0

0.5

1

1.5

1

0.75

0.75

0.5

660-679

0

1

2

2

2.25

1.75

1.75

1.25

640-659

0.5

1.25

2.5

2.5

2.75

2.25

2.25

1.75

620-639

0.5

1.5

3

3

3

2.75

2.75

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