Let’s Talk Credit: Understanding your Credit Score

Did you know?credit score

  • FICO is an acronym for Fair Isaac and Company.
  • In the 1950’s, Fair Isaac and company created the mathematical calculation that is used to determine your credit score.  It is a tool that was designed to determine one’s credit score and dependability in paying bills.
  • The terms credit score and FICO score are used synonymously.

Twenty or so years ago, lenders and banks would obtain the credit scores from the credit report as a reference point.  Loans were based on the overall financial strength of a borrower and their ability to repay a loan.  The Scores were important but they were not weighed nearly as they are today when making a decision.  If scores were on the low side, compensating factors were looked at such as: additional monthly reserves, the amount of credit accounts you carried, the amount of credit accounts that carry balances, do you have a retirement accounts, etc.  Banks in general want to see that you have at least 6 months of reserves in case you should leave your job and have a few months to carry the loan.  In the case where the loan is riskier or may be a low down payment, the lender will want to see more months of reserves, upwards of 12 months.

Your credit history shows the investor your ability to repay and manage debt.  The older the line of credit, the greater the chance of the scores being higher as credit is based on history.

In today’s lending market, your credit decision is first based on the score and can have an effect on your final mortgage rate.  In general, most banks will not lend on loans with scores that are under 640 unless there is an exception or compensating factors, but this is very limited.  Many banks today won’t go below 680 and don’t allow for any compensating factors as they feel these mortgages are far too risky to have on their books.  Based on current mortgage guidelines, if your score is under 740, it will affect the price of your mortgage rate and you are penalized.

When making a credit decision, banks and lenders will pull your credit report that offers three different reporting agencies;  Experian, Trans Union and Equifax.  The middle score of the three credit bureaus is used.  Over time, these scores will be very close to each other.  Consumers who are just starting to build credit may find a discrepancy in these scores as not all creditors are required to report to all three bureaus.

Look at how a Credit Score affects your Mortgage Rate

The higher your FICO scores the less you can expect to pay for your loan.

For example, on a $200,000 Loan using a 30 YEAR FIXED RATE MORTGAGE.

Your FICO score is:

Your Interest rate is

And your payment is

740-759

3.875%

$940.47

739-720

3.990%

$953.68

700-719

4.125%

$969.30

680-699

4.250%

$983.88

660-679

4.500%

$1,013.37

640-659

4.625%

$1,028.28

As you can see in this example using a snapshot of the same day’s rate, a person with a FICO score of 760 or better will pay $88 less per month for a $200,000 30-year, fixed-rate mortgage than a person in the lowest score category.

Mortgage Rates are only used as an example and do not reflect the interest rate market of today.

Mortgage programs such as FHA allow for low credit scores so that you can get the most competitive rate but this comes with a price.  FHA will charge mortgage insurance, a monthly fee as well as an up-front fee that will be rolled into the loan amount.  After these insurance fees, a mortgage rate of 4.00% will net a rate of 5.40% with the costs of mortgage insurance that is being charged.  A mistake many borrowers make; chasing the lowest interest without truly understanding the real costs of the mortgage.

Written by Bill Nickerson

The First Selfie

 

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One Reply to “Let’s Talk Credit: Understanding your Credit Score”

Please leave a reply. Thank you! Bill

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