Your Credit Score
At no time in history has your credit score been of more value to you than when obtaining a mortgage. Credit score represents a borrower’s willingness and/or ability to repay debt. Scores can range from 350 to 850. Your score is calculated through analysis of your current credit situation, including debts, payment history, and types of credit. It is important to note that payment history accounts for only 35% of your overall score, meaning it takes more than just paying your bills in a timely manner to increase your score. Attention must also be focused on the amount owed vs. credit limit (30%), length of credit history (15%), new credit accounts (10%), and types of credit in use (10%). A good goal would be to keep revolving (credit card) balances below 50% of the credit limit. Also, limit the number of new accounts opened each year; hang onto that credit card you’ve had for years even though the rate may be just a touch more than the latest mail offer; and avoid high-interest personal loans. In the current mortgage market, borrowers need at minimum a 720 score in order to obtain the best rate. From there, rates increase on 20-point increments down to 620, where you’d be paying a much higher rate than the 720 borrower. Keep in mind, a mortgage is typically by far our largest debt. Is it really worth opening a new credit card to save a small amount and in turn paying thousands extra in mortgage interest?
Credit reporting errors are another cause for concern. Nearly 80% of all credit reports contain errors of some kind. Recent studies also indicate that about 25% of these reports contain mistakes so egregious that applicants could actually be denied credit. Taking this into account, the first step in putting your best foot forward is making sure everything in your credit file is accurate. Monitor your report. Get a copy of your credit report every six months, and obtain the report from a reputable source that provides accurate scoring. Many on-line sites use their own scoring system that varies greatly from what lenders actually see when the official report is pulled. If you find a mistake, notify all three reporting agencies immediately. (Contact information for all three is provided below.) Once notified, the agency has 30 days to investigate and respond. If the information being reported cannot be confirmed, the item should be removed.
For lenders, income is another tool used to assess your overall risk factor. Let’s be honest, if you’re looking to obtain financing in the next few months, it is unlikely that your income will change drastically in that period. However, whether you are salaried or self-employed, there are a number of tax implications that can have a negative impact on your debt to income ratio or DTI. The DTI is calculated by dividing the amount of your monthly obligations by your gross monthly income. There is not a “set in stone” DTI requirement, but a good rule of thumb would be to keep it under 41%.
This is an area that most borrowers don’t consider, but the more money (also called reserves) you have left after closing, the less risk you pose in the eyes of lenders. This takes into account any liquid (checking, savings, money market, etc.) assets, investment accounts, retirement accounts, etc. The days of 100% financing have nearly become extinct, so a down payment will, in most cases, be required. The risk on a loan increases when every dollar saved must go into the transaction for down payment. Once again, there is not a “set in stone” requirement, but at least two months’ worth of mortgage payments in reserve after closing should be saved. More is definitely better in the case of reserves.
These are all factors that are looked at when lenders make a decision on whether or not to approve your mortgage. In many cases, one can be overcome by another. If credit score is just a bit off, but the DTI is low and assets are strong, don’t count yourself out. These are called “compensating factors.” Always work on deficiencies in credit, which can be improved with reduced debt and increased savings.
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