The three C's of your mortgage loan approval
January 15, 2014If I asked a random sample of shoppers, most would have heard of the 4 Cs of diamonds: Color, Cut, Clarity, and Carat Weight. Those who have heard of the 4 Cs may not be able to name all four, but most would know that each of the Cs will have an effect on the price of the gem.
In mortgage lending we have 3 Cs that underwriters use to determine the qualification for a loan. Changing any of these Cs will change the price – that is the interest rate and cost of the mortgage insurance on a mortgage loan. The three are credit, capacity (debt ratios), and collateral (down payment).
Over the next couple weeks I will examine each of the factors.
First up is credit.
A mortgage application includes a credit report from all three credit bureaus: TransUnion, Equifax, and Experian, including the credit scores from each of these bureaus. The generic name for a credit score most people have heard of is the FICO score, which was developed by the Fair Isaac Company. Equifax calls their score Beacon.
Credit scores numbers go up to 850. Any score over 780 is basically perfect credit.
It sometimes comes as a surprise that the credit scores are different, sometimes very much so, for each of the bureaus. There are a couple of reasons for this. The first is that not all creditors report to all three bureaus. If you have a late payment on a credit card that only reports to one credit bureau, the credit score for that bureau will be lower than the other two. The second reason is that the computer program each of the bureaus use will give a different score with the same information depending on the weight the program gives to loan balances, late payments, number of inquiries, etc.
The middle of the three scores is used for underwriting, and when determining the interest rate on the loan.
A higher credit score will result in a lower interest rate on a conforming loan – one that conforms to Fannie Mae guidelines. A lower credit score will increase the rate on a conforming loan, or lower the chances of loan approval on a government loan such as an FHA or VA loan.
"How do I increase my credit score?" is a question I hear daily. There are several things you can do to increase and maintain your score.
First, pay your bills on time! This may seem obvious. However it is the factor that carries the most weight in determining your credit score. Recent late payments and open collection accounts can sometimes take hundreds of points off a credit score.
The amount of debt that you carry is the second most important factor. Credit cards with high balances will reduce your scores. Keep balances, relative to the credit limit, below 50%. Lower is better. However, it is important to use your credit cards on a regular basis, at least for small charges. An inactive card will actually hurt your credit.
The next factor is length of credit history. DO NOT close a credit card without consulting with your mortgage professional first. A low balance is good, but closing a credit card will reduce the length of your credit history and the amount of available credit, both of which will lower your credit scores.
New credit will lower credit scores, at least initially. The number of times your credit report is run, known as an "inquiry," can have a negative effect on your scores. A few inquiries will have a minimal effect if you already have good credit, but numerous inquiries, especially for credit card applications, can be significant.
The last factor is types of credit used. The two main types are installment loans, such as an auto loan or home mortgage, and revolving credit, such as a credit card. The best credit scores I have seen belonged to borrowers with one installment loan, the best being a mortgage, and a couple of credit cards with low balances and high credit limits, along with a long on-time payment history.
Next week, the second C: Capacity.
John Yeager is the Valley Center Branch Manager for Summit Mortgage, NMLS #219612. He can be reached at 760-749-8931 or by visiting www.john-yeager.com, or via email at firstname.lastname@example.org.