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FICO Scores
Now that you have made the
decision to purchase a home, you will have to obtain the financing required to
purchase a home. To acquire a home
loan, you will have to start applying for a home mortgage loan. There are numerous mortgage plan packages
available for various terms, but before choosing a mortgage plan that is
advantageous to you, there’s the whole process of being approved for a home
mortgage loan.
Therefore, when you’re applying for approval for obtaining a mortgage loan, you
will invariably have to deal with credit scoring. Credit scoring refers to a sophistical mathematical model that
outlines a loan applicant’s credit behavior and the credit behavior of other
borrowers. Loan sources use this form
of analysis as a way to improve their accuracy in determining the credit risk
that each potential lender has.
Despite the fact that there are numerous methods of credit scoring, the most
popular form of credit scoring is FICO scores.
FICO scores is a mathematical credit scoring model that was created by
the Fair Isaac Credit Organization (FICO).
Similar to other credit scoring models, FICO scores produce an output
that measures a lender’s ability and likelihood of paying their bills on
time. It produces this numerical score
by examining such fiscal determinants as:
Credit history
Income levels
Outstanding debt
Debt utilization history
Access to credit
A FICO score is a numerical
value that ranges between 300 and 850, with the low end of the scale
representing a poor credit risk. Loan
sources then use this FICO score to determine whether or not a prospective
homebuyer is eligible to receive a home mortgage plan in the first place and
then use this same score to establish the number of mortgage plan options that
is accessible to the prospective homebuyer.
Many loan sources point to a FICO score of 620 as the cutoff point for
loan eligibility. Any FICO score lower
than 620 does not automatically preclude a prospective homebuyer from obtaining
a home mortgage loan, but they are usually only able to acquire a mortgage loan
from the private sub-prime market where mortgage interest rates tend to be
higher due to the credit risk represented by the borrowers.
Before you become
intimidated before applying for a mortgage loan due to the importance of the
FICO score, it may aid you if you understood what makes up a FICO score. According to the Fair Isaac Credit
Organization, their FICO scores are made up of these components:
Payment histories on a prospective borrower’s
credit history make up 35% of the score.
In the interest of fairly analyzing a borrower’s credit worthiness,
FICO scores weigh recent credit history more heavily than credit actions
that took place in the distant past.
An additional 30% of the FICO score is based
upon the amount of debt that a prospective borrower has outstanding with
all creditors.
The length of time that a borrower has been a
credit user makes up 15% of the FICO score component. As a rule, it is better as a borrower
to have a longer history as a credit user if they also have a history of
making timely payments.
Another 10% of a borrower’s FICO score relates
to the borrower’s very recent history.
This component analyzes the effort that the borrower went through
to obtain loans or credit lines in the previous months before applying for
a home mortgage loan.
An analysis of a borrower’s credit makes up 10%
of their FICO score. The score
reached from this component comes from the mix of credit that the borrower
holds such as installment loans (car loans), leases, mortgage, credit
cards, and other forms of credit.
In addition to the breakdown
of how FICO scores are accumulated, it should be noted that there are some
factors that will negatively affect a person’s FICO scores. These include:
Delinquencies
An excessive amount of accounts opened within
the previous twelve months before applying for a home mortgage loan.
Short credit history.
Reaching close to maximum limits on balances on
revolving credit.
An absence of recent credit inquiries.
Public records (ie. tax liens, judgments, or
bankruptcies).
No recent credit card balances.
In recent years, FICO scores
and other forms of credit scoring have taken on greater importance. Previously, loan sources determined the
credit worthiness of a borrower solely on the past payment history of the borrower. However, studies were conducted that
measured the correlation between credit scores and mortgage delinquencies. Based on these studies, lenders discovered
that there was a definite relationship between a borrower’s credit score and
the likelihood of the borrower being ninety days delinquent at least once
during the span of their home mortgage loan.
These studies have shown this relationship between a borrower’s FICO
score and the likelihood of a ninety day delinquency:
Fico Score: Odds of a delinquent account
595: 2.25 to 1
600: 4.5 to 1
615: 9 to 1
630: 18 to 1
645: 36 to 1
660: 72 to 1
700: 288 to 1
780: 576 to 1
As a result of these studies
in the relationship between credit scores and potential delinquencies on home
mortgages, lenders are now trying to fun loans with rates, fees, and terms that
precisely match with a borrower’s delinquency risk.
Due to the increased
reliance on FICO scores and other forms of credit scoring, there have been
changes in the home lending industry.
As a result of FICO scores, the sub-prime lending industry has
developed. This source of lending
revolves around making loans to borrowers that do not have the best of
credit. Additionally, loan sources have
credited the use of FICO scores to reduced delinquencies. This has allowed borrowers to use the extra
credit that is now available to them to fund more home mortgage loans. Homeowners also credit FICO scores to
improving their ability to obtain a mortgage.
This is because FICO scores provide a definite mathematical output that
enables lenders to make loan approvals quicker, simpler, and more convenient
for a variety of loans.
However, FICO scores and
credit scoring have taken away the ability of prospective homebuyers to
leverage more advantageous deals among lenders. This is because prior to credit scoring, borrowers were able to
view the results of the underwriting process from one lender and search for
better deals among different lenders.
As a result of this widespread reliance on credit scores in determining
credit worthiness by lenders, prospective borrowers are unable to leverage
their credit status for a better mortgage loan plan. This is because FICO scores are usually not released to the
borrower. It is sometimes possible for
a borrower to obtain a credit report that contains their FICO scores but this
service is not free.
As a result of FICO scores,
things have changed when it comes to obtaining a mortgage loan. Many of the resulting changes caused by FICO
scores have been positive and some have been negative, however, it is important
to relate to the reader that FICO scores are not the sole determinant over
whether or not they are able to obtain a home mortgage loan. Rather, the results of the FICO scores make
up guidelines that allow the loan source to determine what mortgage loan
programs that the borrower is eligible for, if at all. Therefore, if you have a low FICO score, you
shouldn’t overly worry as your loan source’s underwriter will look at other
factors before determining what mortgage loan you may be eligible for. These factors include:
Large down payment made on the home.
Low debt-to-income ratios.
An excellent proven history of saving money.
Reasonable explanations for factors found within
their credit history that has negatively impacted their credit score.
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