If you figured that the sub-prime mortgage crisis wouldn’t negatively affect you due to your particular situation, you might be surprised to find that isn’t necessarily the case.
Building on the axiom "once bitten, twice shy," lenders have become more circumspect in how they give out money. And the changes have affected even those who previously thought they had nothing to worry about.
How? By making your credit score more important than it has ever been.
"The FICO score is a pretty elusive thing to pin down," says M. Brent Foster, a mortgage specialist with First Horizon. "It’s a proprietary, secret formula and no one knows all the factors which go into it, which can be frustrating."
Frustrating can be an understatement. FICO the Fair Isaac Corp.’s scoring system is used by most lenders, but because there’s a lack of transparency in the formula, knowing how one of the credit reporting agencies arrives at your score borders on the occult.
And credit reporting is not flawless. Indeed, while all three reporting services TransUnion, Equifax and Experian enter their data into the same FICO score model, each obtains its information independently, and not all of it may be up-to-date or even accurate.
"They might have different balances on your accounts, and someone else’s credit is being reported as yours," Foster says. In other words, their errors could lower your credit score, and a lower score can now, more than ever, raise the interest rates charged on loans.
Foster stresses that it is difficult to generalize and many other factors are involved in the loan process, "but the FICO score plays a prominent role in selection of rates." Before, if your loan was "conventional, conforming" (i.e., less than $417,000 under normal 30-year terms), FICO did not affect the rate. That’s no longer the case.
"For credit scores less than 680 and down to 575, there will be add-ons" even for a conventional loan, Foster says. It usually takes a swing of 10 to 20 points to affect it, but "if you are on the lower range, expect to pay 1 percent more than everyone else."
So what counts as "good credit?"
Generally, "good" is "anything over 700 over 800 is excellent," says Foster. "You’re still not going to experience an add-on on anything over 680 on a conventional loan."
When it dips below 680, credit is considered only fair; drop another 100 points, and you’re considered a high-risk borrower. And according to Foster, "Texas has the lowest average credit score of any state in the union."
The effect of the credit score may be most obvious for people seeking unconventional loans. First Horizon, for example, offers numerous programs for its clients, but lower credit scores may limit borrowers’ options.
"Say you have a score of 610," Foster uses as an example. "That will knock out of a lot of 100 percent financing programs and may require a greater down payment percentage than before. You might only get an 80 percent loan," meaning that you will need to deposit 20 percent of the purchase price as a down payment and not be eligible for a second loan to make up the difference.
The mortgage industry is used to such rules. Loans greater than $417,000 are considered "jumbo" and have always been subject to risk-assessment. And ironically, loans of less than $50,000 are often subjected to higher interests rates because they are considered "too small."
"There is a considerable up-charge for loans less than $50,000," Foster says.
To make matters more confusing, in December FICO announced that it would be revising its criteria. While the range will still be 300 to 850, FICO is reconfiguring its model to reflect young lenders with less credit history, or give extra points to those who diversify their credit. This means that two people with identical scores today could find themselves with different scores tomorrow.
So what are ways you can keep you credit score high? Foster offers these suggestions:
Establish credit early. The length of time you’ve had credit will be a factor. The longer you keep the same cards or accounts open, the better it looks to a lender.
Use credit sparingly and wisely. "Reporting companies will look at all your credit cards combined, but they also look at each card individually," Foster says. "You never want to be over 50 percent utilization [that is, more than half your available credit outstanding at any time] and 80 percent is really bad."
Maintain your credit. This is code not only for paying on time, but also avoiding adverse judgments and minimizing inquiries (i.e., do not apply for every credit card application that falls out of a magazine).
Diversify your credit. "You get credit for positive marks for using different types of credit," Foster says. If you maintain revolving credit (charge cards) and a savings or checking account and a car or student loan and a mortgage, that makes you look desirable to a lender.
And just like on the dance floor, desirability is everything.
This article appeared in the Dallas Voice Defining Homes print edition March 7, 2008