Most homeowners shopping for a mortgage loan are aware of just how important their credit score is in determining the rate and terms that they will be offered. Practically all lenders use a “tri-merged” credit report, which is one that combines the data and the scores from the three major credit bureaus: Equifax, Experian, and TransUnion. The middle score is used to underwrite the mortgage.
Fair Isaac, the company that created the FICO score, announced that it will soon implement changes to the FICO model. According to a recent article in the Wall Street Journal, those changes are expected to boost those with excellent scores and hurt those with lesser scores, thus widening the gap between consumers who are considered good credit risks and those that are not.
Among the changes are harsher treatment of late payments and rising debt levels and penalizing consumers who obtain personal unsecured loans, such as those offered by many credit card issuers. It is believed that millions of consumers could see their scores rise or fall as a result of the changes.
As to what this means for each individual looking for a mortgage, best practices for credit use have not changed much. On-time payments are the single most important factor in your score. However, these changes to the FICO model will increase the importance of other factors such as the amount of credit outstanding compared with your total available credit and, in the case of personal loans, the type and purpose of the credit obtained. Apparently there are good loans and not so good loans.
As always, the simplest advice is the best. Use your credit wisely and your score will help rather than hurt you.
Steven H Hofberg, Operations Manager
This week, I will address those items that should be followed
by everyone regardless of score. Keep in mind that credit score
management is a marathon, not a sprint. Your actions will take one or
more months to come to fruition; sometimes a year or more in difficult cases.
Here are four tips that everyone should follow regardless of
1. Make Sure Your Credit Reports are Accurate
Most everyone has three credit reports, each one from the
major credit bureaus – Experian, Equifax and Transunion. Some credit
providers chose one of the three, but for mortgage credit we must have a
“tri-merged” credit report, which means a combined report including
information from all three bureaus. A recent study by the Federal Trade
Commission found that 20% of consumers had at least one error on their report. Your
credit score is based on the data in those three bureaus, so checking them
for accuracy is very important. You can do that for free once a year at AnnualCreditReport.com, the website run by the major bureaus under a mandate of the
federal Fair Credit Reporting Act. Once you get the reports, check for
errors in personal information (name, address, etc.), and review the list of
credit accounts for accuracy. Disputes have to be filed with each bureau
separately, and each individual dispute should be filed separately, meaning
three disputes for each error.
2. Build a Strong Credit Age
For young people especially, having a short credit history
will hinder your scores. A good average age for a credit history is five
years or longer with at least three tradelines, or creditors. Someone
with only a one year history will have significantly lower scores than
someone with the same on-time payment record but over five years. So
establish credit as soon as possible in your adult life (see the next section
on getting and using a credit card).
3. Get and Use a Credit Card
Apply for and maintain at least two credit cards. Three
would be better. Once you receive them, make at least one charge per
month on each, and pay off the balance each month so you don’t incur interest
charges. This will build your “Credit Age” as discussed above. But
fair warning, if you make payments late on any card, your scores will drop
substantially. Use your good credit wisely and don’t buy more than you
can afford to pay off in a short period of time (ideally by the end of the
4. Monitor Your Credit Utilization Ratio
One of the most important factors affecting your score is your
credit utilization ratio, which is the percentage of available credit that
you are actually using. Try to maintain a 15% ratio, meaning that if you
have a combined credit card limit of $20,000, your total credit card balances
should be $3,000 or less, even if you pay off the entire balance at the end
of the month. In any case, try never to exceed a 30% credit utilization
ratio, or your scores will drop substantially. This is also the reason
you should not close old credit accounts. Keep that available credit
limit to lower your ratio, even if you rarely use the card.
Have a great week!
Steven H Hofberg
Next week: More tips to improve your credit
Quick Credit Guide
Are you thinking about
buying a home? Use this guide to boost your credit score!
Get one or two credit cards
to grow your credit history
Debit cards do not
count towards your score
Use the card/s each month
Pay them off each month
Pay on time
If you cannot get a credit
card, get a secured card by putting money “down” on a bank card
Increase the credit limit on
Keep track of your debt-to-credit
limit ratio. You should aim for a ratio of 30%, but the lower the better.
Don’t close old, paid-off
debt – it looks good on your record (like getting A’s in high school)
Pay off disputes and then
fight them (cable companies, medical bills, etc.)
Limit inquiries on your
Monitor your credit – www.annualcreditreport.com
can give you all three bureaus once a year (checking one bureau every 4 months
will give you an idea of how your credit score is doing).