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Raising Your Credit Score History of Credit Score
When I started into real estate, buyer’s were qualified to buy with the use of a ratio of monthly payment to monthly income with some check on your past credit report. Today lenders offer you a loan based on what they see as their “risk” which is based on: 1. Your ability to pay back the loan
2. Your past willingness to pay back loans.
They use your credit score to decide if you have shown willingness to pay back loans. According to Jeff Furr, of Myers Park Mortgage, the most widely used credit scores are the FICO scores, which rate you between 350 (high risk) and 850 (low risk).
Your credit score is based on different portions of your credit history and each has an assigned weight in the formula. 1. Payment History 35%
This includes past delinquencies and
derogatory payment behavior. 2. Current Debt Level 30%
3. Length of Credit History 15% The longer the credit history the better. 4. Type of Credit Available 15% This is installment loans with a set balance vs.
Revolving and debit accounts like credit cards 5. Credit Score Requests 5%How often your credit score has been requested as you apply for new avenues of credit.
To have a credit score, you must have at least one credit account that has been open for 6 months or more and at least one account that has been updated by the creditor in the past 6 months. This ensures there is enough information to generate an accurate credit score.
With this new credit score method of qualifying for a loan, you can get a loan with almost any score. The problem comes in the fact that the higher the risk to the lending company, the higher the interest rate. High-risk buyers often end up with loans whose payments are so high that the ratio between the monthly payment and the monthly income becomes prohibitive.
I have seen too many people take these loans figuring that in a couple of years they can refinance. If they have layoffs or other work reversals, these buyers often loose their homes to foreclosure, which can stay on their credit for up to 10 years. The better way is to work with a financial advisor to raise the credit score and then buy with a conventional loan.
Dos and Don’ts
I’m writing this newsletter mainly because I’ve seen that much of the old advice on how to improve your credit is no longer the best advice. Let me go over a couple of the problems that I have regularly seen hurt credit scores.
Advice # 1: The old advice was to consolidate loans into one large loan with one payment and close out any accounts that were not being used. This helped the old “ratio between monthly payments and monthly income” method. Today, FICO takes into consideration how much of a credit line you are using. Now it is better to have 3 credit lines where you are using only 30-50% of each of your credit limits. The amount owed may be the same, but the percentage of your available credit is different. This also means you can raise your score by having credit lines with no balance. Credit score companies seem to give you a higher rating if, for instance, you have a total of all credit lines of $30,000 and owe only $10,000 than if you have one credit limit of $15,000 and owe $10,000.
Advice #2: Watch out for having your credit pulled by too many lenders in a short period of time, especially if they are lenders that do both mortgage and revolving credit accounts. The FICO score-keepers take into consideration that a smart buyer checks out several sources when buying a new house or car. But if it looks like you are shopping for a lot of other revolving credit items such as credit card or furniture loans, your credit score will begin to take hits because of Credit Score Requests. I have seen some of these companies that advertise to have the lenders fighting over you cause Buyers too loose significant points with 10 or so credit pulls within a few days.
Just an added note:
John DiFiore, with Residential Mortgage Center, recently told me that more changes in this credit score system are on the way. I’ll keep you informed when I find out any additional information.
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