Sunday, June 3, 2007

Fix Your Credit, Get a Better Loan!

Berkeley Hills Realty
News You Can Use
Summer 2007 Issue

Giving Credit Where It’s Due
How to Improve Your FICO Score

By William Rodarmor

Anyone who has considered buying a home recently has heard the term “FICO.” It’s an acronym, and short for Fair Isaac Corporation. That company develops the software used by the three major credit bureaus to calculate their financial data on consumers. The bureaus use different names for the resulting numbers, but “FICO score” has become a universal shorthand way to describe a person's creditworthiness when they apply for a mortgage. (FICO scores range from 300 to 850. By law, each bureau must give consumers one free credit report every year.)

Most loan brokers find FICO scores convenient, some think them overly rigid. But love them or hate them, credit scores are here to stay. They make a big difference in how much borrowers pay for loans, so it’s worth finding out what factors affect your score and how to make them work to your advantage.

“FICO scores are huge now,” says Robert Jackson, an East Bay loan broker with BayCal Financial. “The credit score is the most important item that banks look at nowadays. They also look at your current amount of debt, job history, income, amount of savings, and how much down payment you are making. But the FICO score has become the real predictor of how you're going to pay your mortgage back.”

Paul Riccardi, president of MPR Financial in Albany, agrees. “Lenders now are very credit-score driven,” he says. “Income and assets are taken into account, but credit scores have become a sizable portion of the way a person's credit worthiness is evaluated.”

“In the old days, the numbers that mattered were your age and weight,” says Hazel Valera, a credit consultant in San Jose. “Today it’s your FICO score.” Valera claims that she once even heard a woman say that if you're thinking of going out with a man, “first find out what his score is.”

A Short Course In Score

A bank’s decision to lend someone money is based on risk, and one way to evaluate that risk is to look at the person's history of paying other people back. That's reflected in credit scores. A borrower with a high score, documented income, and other favorable factors is a desirable customer to do business with. (Also, loans are often resold on the secondary mortgage market, so the better the overall package, the more salable it is.)

The picture is clearest at the low and high ends of the score range. With a score of 550, you pay through the nose. With a score of 820, you get the red carpet. The chart makes this painfully clear. On a fixed-rate 30-year $700,000 loan, someone with a 550 score will pay $2,601 more a month than someone with an 820 score, and pay $936,341 more in interest over the life of the loan.

“As a general benchmark, if your credit score is over 720, your eligibility is increased,” says Riccardi. “Also, you can increase your loan to value to 100 percent financing. If it goes over 740, in some cases you get pricing compensation; the lenders knock off a percentage of your loan fee because your score is so high. That’s a rarity, but they will do it on occasion.”

But what about more average borrowers who want to buy a house, can document their income, and have a FICO score between 620 and 680?

“A 680 credit score is right in the middle of the road,” says Sam Krueger, a residential loan consultant with First Residential Mortgage Consultants in Berkeley. “If you're able to document your income and are putting 20 percent down, you’re probably going to get a really good loan.”

“In general, a score of 680 or better will get you in the door to almost all loan programs,” says Lisa Wagner of KLA Mortgage in Berkeley. “The higher the score, the better the lender likes it.” At 720 or better, some lenders may give you a discount, says Wagner. “They might give something back on the points, for example. Depending on the size of the loan, that can represent a significant savings.”

How to Improve your Credit Score

FBut what if your score is around 620 or below? It takes work, but there are a number of things you can do to raise your score and the esteem in your banker's eyes. Be warned, though: It's hard to change your credit score in a short period of time. It usually takes six months to a year to show results.

“I would get in touch with a mortgage broker and have a loan application and credit report pulled so you work on any potential problems,” says Jackson. “In fact, it's a good idea to pull up your credit report at least once a year to make sure that everything is being reported correctly. There are serious errors on lots of them.”

“Credit reports are usually pretty clear as to where the problems are,” says Riccardi. “Late payments, collections that have gone unpaid, balances that are too high. Or maybe something happened in the past that hasn't fallen off the credit report yet. All of these can affect that score.”

That said, there are many ways to maintain a high score or improve a low one.

Have multiple lines of credit. The ideal number is four open lines of credit, says Jackson-a car loan, a mortgage, and two credit cards, for example. “Use these 'lines' actively, and pay them off on time every month,” he says. “That keeps your score high.” Store cards-whether from Nordstrom or The Good Guys-don't have the same weight. Stores just don't extend a lot of credit, even to good customers.

Low balances, high limits. Keep balances low and credit limits high. A balance of less than 50 percent-30 percent is even better-on a card with a $10,000 limit is helpful. To lower a high balance, spread the money owed among a number of accounts, so it’s not over 50 percent on any single card.

Guard your older credit accounts. Even if you feel you have too many credit cards, don’t close the ones you’ve had for a long time. “The payment history on an old account counts for 35 percent of your score,” says Valera. “That’s the largest portion of your score.” It’s best if the accounts were opened some years ago, and show a perfect payment record.

Make all payments on time, especially your mortgage. “It's crucial not to have late payments on current mortgages,” says Wagner. “Those will hurt you with the lender more than any other kind of late payment you can have.”

Beware of unpaid medical bills. “Medical bills are notorious for causing problems,” says Jackson. “People go to the doctor and think their insurance company has paid the bill. But when they apply for a mortgage, they discover they've had a collection pending for the last two years.” Valera agrees: “Your ambulance bill will go straight to collections even before it gets to your insurance carrier, so if there is a mistake, it ruins your credit. Even if you pay it, the collection stays on your credit report.”

Pay off past due accounts, but let sleeping dogs lie. “Paying off a really old debt can actually hurt you,” says Krueger. “If you have an account due on your credit report that is a four or five years old, it will often be worse to pay it now, because that makes it more recent.” Just wait, he says. “After seven years, things are supposed to drop out of the score.”
Avoid public liens and judgments. Don't get into a fight with the guys who screwed up your kitchen remodel. They might slap a mechanic's lien on your house, and it will linger on your credit report even after it’s been satisfied. Bankruptcies, public liens, and judgments can stay on your credit report for ten years.

When asking for a mortgage, don’t apply for new credit. There are two reasons for this. First, you are showing the lender a snapshot of your current finances, so don’t change the picture while it's being looked at. Second, applying for new credit generates inquiries on your credit report, and the more inquiries you have on your credit report the slower the bureaus become, says Valera. There are two types of inquiries, “soft” and “hard,” she explains. A “soft” inquiry is what happens when you ask for your credit report from or directly from one of the bureaus. A “hard” inquiry occurs when you actually apply for a loan.

Take your name off marketing lists. People often wonder why applying for a mortgage seems to trigger a flurry of marketing solicitations. It’s because the credit bureaus sell your personal data to banks and mortgage companies. This can generate an onslaught unsolicited marketing material, and may even lower your credit score a bit. Valera urges her clients to sign up at “That takes your name and address off all the lists that the credit bureaus use to sell marketing data,” she says. “It will reduce your junk mail and all those offers for pretty 0% interest cards. I can't prove that going to actually increases your score, but my clients gain 5 to 7 points every time they do it.”

Piggyback on someone else's established credit. “Here is a trick that can increase your score a lot, and it's especially useful for young people,” says Krueger. “Suppose you're a student in your twenties with a student loan and one credit card, and your mom or dad adds you to their credit card: Boom! You now have ten years of credit history. It's like magic.” The primary holder's card will appear on your credit report, he says, and the report will treat that account as if it's yours. That way, you benefit from the card's low balance and long payment history.

Watch out for the little things. Small errors in a credit report can have a large impact. One Albany couple recently came to see a local mortgage broker with a tale of woe. They said that Bank of America had issued them a credit card that they didn’t use, and had been mailing the statements to the wrong address. “They never used the card, so no payments were made for four or five months,” says the broker. “It dropped their credit score 120 points!” The broker contacted B of A to clear up the mistake, but without success. “The credit card division was a complete pain about it,” he says. “This was a simple little error that wasn't my clients' fault, yet it was quite a ding to their credit.”

Is FICO a Four-Letter Word?

Loan brokers know a lot about credit scores, but that doesn’t mean they like them. “I hate these scores,” says one broker. “They're arbitrary, and a lot of erroneous information appears on people’s credit reports. I’ve seen people with bad credit but high scores, and vice versa. You might be a good credit risk but have a poor score because of one stupid thing you did. But that's the way it is now, so you have to play by the rules.”

Hazel Valera studies those rules carefully, and says she uses them to her credit clients’ advantage. “One thing I like about FICO is that if you make a mistake, you can correct it in six months. Before FICO came along, if you had a bankruptcy, that was it. Nobody would talk to you for seven years!” Today, Valera claims she can help people get right out of bankruptcy and buy a house when they are gainfully employed again. “But they have to follow my plan, and work at it,” she says. “The worst thing you can do is to do nothing.”

Sam Krueger isn’t crazy about credit scores, but has learned to live with them. “In the early days, you could write letters about unfavorable items on a credit report and explain them away,” he says. “Some lenders still operate that way, but very few.” On balance, however, he says that credit scores work okay. “We could probably come up with a better system, but credit scores are like SAT scores. Ultimately, they reveal a lot of truth.”

William Rodarmor is a writer, editor, and French translator in Berkeley, California.

© 2007 by Berkeley Hills Realty

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