| Fico Scores | ||
| FICO scores are credit rating scores based upon a rating system developed by Fair, Isaac & Co. The three main credit agencies, Experian, Trans Union, and Equifax, provide the scores to their creditor customers as a means of helping them make a decision whether or not to extend credit to a potential customer. The higher the score, the better the credit risk. The lower the score the greater the likelihood that the account would be a problem, either paying late or not at all. | ||
| Experian calls the scores "FICO scores" but the other two bureaus assign a different name to their system, even though Fair, Isaac & Co. developed all the underlying systems. Equifax calls it the Beacon score and TransUnion calls it Empirica score. When you get a credit report from each of the three bureaus, the scores will not be the same. First, not all creditors report to each agency so the underlying data are different. Second, the scoring systems are slightly different. | ||
| Secrecy | ||
| In one of the bizarre occurrences that happens these days, Fair, Isaac & Co. and the bureaus decided that they would not make the scores public to borrowers. Personally, I think that they didn't want to listen to a bunch of consumers whining that their score was too low. Anyway, we had a system where creditors would make a credit decision based upon the score but the customer couldn't find out what his score was. Obviously this is important to a consumer, especially if his score is low enough to be a problem. | ||
| As a result of changes in the law in some states, consumers can now get their FICO scores. Experian has partnered with Fair, Isaac & Co. and you can get a report with your score at http://www.myFICO.com. The cost is $12.95. | ||
| If you are about to select a lender to work with - and you should if you are thinking of buying a home - then you can ask your lender to pull reports from all three bureaus and get all three scores. The cost is less than $25. | ||
| FICO Scores and the Mortgage Industry | ||
| Fair, Isaac & Co. developed its scoring system with its agency customers principally for use in extending consumer credit, credit cards and revolving accounts at department stores and the like. This accounts for about 90% of the credit reporting industry's business. Mortgage companies are only about 10% of the business. Interestingly and critically important is that no one, including Fair, Isaac & Co., has ever done a statistical analysis to correlate credit scores with the likelihood of mortgage default. | ||
| This is important because if there is a difference between the way people treat their mortgage and the way they treat their other bills, the result will be a difference in the predictive accuracy of the scoring system. If a borrower is a little short, my belief is that he will make his mortgage payment on time even though he might let some of his credit cards slide. The fundamental difference in behavior calls for a separate rating system and Fair, Isaac & Co. tells me that they have made several attempts to work with the mortgage industry to develop such a system but were unsuccessful. | ||
| Notwithstanding this fundamental flaw in the system, the mortgage industry jumped on the use of FICO scores like a duck on a June bug. It is a quick and easy means of simplifying the underwriting process. Rather than have underwriters have to think and analyze the importance of various derogatory information on a report, the lenders let the scoring system do it for them. This has good and bad implications for you as an applicant. | ||
| The good implication is that if your credit scores are good, no one will look at the report itself. You'll likely be approved. The bad implication is that if the score isn't good, no one will look at the report either. Your loan will be denied or relegated to sub-prime category with its higher rates. | ||
| The most insidious implication is that it appears that many lenders who are selling their loans into the Secondary Market - read most loans - seem to have been putting language into the documents that define the quality of their loans like this: | ||
|
The
borrowers of all loans in this pool have minimum FICO scores of
660.
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| What this means is if your FOC score is 659, you will NOT be approved by that lender, at least for the program with the most favorable rate, or not at all. | ||
| Beyond FICO Scores | ||
| The better news for the people who are likely to be reading this is that your loan will probably qualify for being underwritten by the Automated Underwriting Models developed by FannieMae and FreddieMac. FNMA's system is called Desktop Underwriter and FHLMC's is called Loan Prospector. In both cases, credit reports are pulled directly from the system when the originating lender or broker enters the data into the system. Each agency has its own back room of PhD's and statisticians and the systems they have developed, while no doubt similar to the Fair, Isaac & Co. models, do not appear to use the FICO scores themselves. As a user of these systems, my experience is that they are more forgiving than manual underwriting where a person just looks at the scores themselves. | ||
| Other major lenders have their backrooms of PhD's too and they are developing their own computerized underwriting systems that will most likely rest upon their own assessment model, not FICO scores. | ||
| Implications for Consumers | ||
| If your credit scores are above 680, you are going to be approved for A-paper loans by any lender in the Western Hemisphere. If your scores are above 700, some lenders will give more attractive pricing. One lender I use reduces the fee .25 points if the score is above 720. On a $275,000 loan, .25 points is $687.50, worth seeking such a lender. I do not know if this system has crept into direct retail lending by banks, but if you are working with a mortgage broker, they are definitely available to them and their customers. If you have an excellent score, make sure that your broker is exhausting all possibilities in his search for the best lender for you. | ||
| If your credit score is below 620 - that's not exact because lenders have different criteria - you are going to be classified as a sub-prime borrower. Seek a lender with "risk-based-pricing" where they will at least give you better pricing than someone with a 580 score. | ||
| If your credit scores are between 620 and 680, you are in a gray area. I would definitely choose a mortgage broker because he has the choice of so many lenders. Do some serious strategizing with him about how to get you the best rate. The first step would be to run your application through one of the AU models. If you are getting a Conforming loan - less than $275,000 - you're home free. If you are getting a Jumbo loan - more than $275,000 - there are some lenders who will take a FNMA or FLHMC approval - as an approval for their Jumbo loans. Your broker will have to find such a lender. | ||
| Final Advice | ||
| Get your credit report. Our industry has been telling people this for 10 years anyway and still most people come into the lender's office having not a clue as to what is on their credit report. I have heard that over 40% of reports have erroneous information on them. I'm not sure about that percentage, but it is pretty common. More important, if it affects YOU, it's 100% in your case. The erroneous information will invariably be BAD information, items that lower your credit scores. You have every legal right to have report that accurately reflects your credit history and creditors are legally obligated to remove information that is not accurate. It is possible to get information removed, especially if it is over a few years old, because creditors purge their files and a few years later, they may not be able to prove if you were late or not. | ||
| You should also go the myFICO website to learn more about factors that affect your score. | ||
| Finally, there are many pages of suggestions on how to clean up your credit report and improve your scores in each of my books. Rather than repeat that information here, I suggest that you go down to your local bookstore or go to the bookstore page to purchase one of my books. | ||
| Good luck! | ||
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Randy
Johnson Independence Mortgage Company, 1601
Dove Street Suite 181, Newport Beach, CA, 92660
Phone (949)-852-8822 Fax (949)-852-0441 Updated 7-5-02 |
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