A Whirling Ball of Credit Confusion

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I run into this every year. Confusion about credit; what it means, what is allowable, what it can do or can't do. Good credit is needed to buy a home these days. Not necessarily blemish free credit, but there needs to be evidence that you are in the habit of paying your bills on time. And by bills, we are talking about credit cards, vehicle payments, student loans, as well as personal loans. There is a direct connection between how a borrower pays their credit cards and installment loans with how they will pay their mortgage loan; past behavior being the best predictor of future behavior. It isn't too far a stretch to conclude that someone who never met a bill they liked to pay, isn't going to like that mortgage payment any better.

So, while mortgage lenders can be forgiving of negative credit, even past bankruptcies and foreclosures, there is a standard that most look for with regard to credit. Generally speaking the floor of that standard is a 640 credit score.

And when I say 640-I mean the middle credit score has to be a 640 or above. And by middle score, I mean the middle score of the lowest scoring borrower. Does that makes sense? Here's how it works:

If the borrower is purchasing the house with no co-borrower we will pull credit from three bureaus-Transunion, Experian, and Equifax. Whichever bureau posts the middle score, that is the one we use. IF we have two borrowers, a husband and wife, let's say- we pull credit on both and we use the lowest middle score. So if husband's Transunion is the middle score and it is a 675 and wife's Equifax is her middle score and it is 653, we will go with the wife's score as the score that determines eligibility for the loan. The only way we can use the husband's middle score as the determining score is if the wife is not on the mortgage.

Often I have young buyers who have a parent who is willing to be a co-borrower to offset low or no credit situations. We used to be able to do that. No more. There is no escaping a credit score that is ineligible for a mortgage to obtain a mortgage.

And why is it that my credit report is 20 points lower than what I just pulled off of Credit Karma? The answer is algorithms. Mortgage lending uses a different set of criteria for calculating credit-so that Experian "Kiss My Credit" ad with the blonde sticking her boots up on the desk? It doesn't necessarily work for mortgages.

The other thing about credit scoring is that lenders want to see accounts on credit reports. That is after all what creates credit scores, accounts that are working for you because you pay them on time and accounts that are working against you because you don't pay them on time...or at all. If there is a body of good credit reporting, it can offset to a degree, any bad credit that might be reporting. It's not a cure all. A credit card and a car payment that are paid on time for 6 months isn't going to help if the remaining 25 pages of the credit report are filled with negative credit. What determines credit are these factors:

1) How much you owe compared to how high your balances are. (keeping balances at 1/3 of the limit will obtain optimal credit on revolving accounts)

2) Timely payments

3) Number of open accounts

4) Diversity of type of account (revolving, installment, student loan etc)

5) Length of time accounts have been open

6) Existing negative credit-this includes late payments, collections, charge-offs, tax liens, and judgments

7) Credit inquiries. Anytime credit is pulled it is noted on the credit report for 120 days. One or two pulls don't make a huge amount of difference, but if someone has their credit pulled seven or eight times in a 60 day period scores can drop significantly. Car dealerships in particular hammer credit as they shoot out credit reports to many different finance companies. I have seen as many as nineteen or twenty credit pulls from one dealership for one transaction. It isn't advisable to shop for a car at the same time you shop for a mortgage unless you plan to finance the car through your bank or credit union who will be much gentler with the credit inquiries.

Your credit score will ultimately affect the interest rate. One of our programs has a 620 minimum score. It is a good FHA program-30 year fixed rate loan. But there is a significant interest rate difference between that program and and FHA loan with a borrower whose score is in the low 700's.

The sooner borrowers develop good credit habits the better if there is a mortgage loan in the future. Remember, the lender is taking the majority of the risk in the process. It's their money on the line and they are betting you will pay it back. Give them a reason to bet on you.