Understanding Credit

Mortgage Financing Made Easy

I. Lending Guidelines

Understanding Credit

There are three C’s of lending: credit, capacity and collateral. This section will focus on credit. You must understand what lenders are looking for in order to qualify you for a loan. How you pay your bills makes a big difference in the programs you qualify for. More importantly, it affects the interest rate you are charged. It is called risk based pricing. Banks and other lending institutions charge higher interest rates for customers with “spotty” credit. For example, a person who always makes their payments on time and has a reasonable amount of credit available will get a lower rate than someone who pays their bills late and has too much revolving debt. Most important is your payment history on mortgage loans and other installment loans. Read on to learn more.

Installment loans differ from revolving accounts in how the contract is written. A car loan is an installment loan. It has a fixed repayment period with a consistent monthly payment. Credit cards are considered revolving loans. They do not have a set payment amount. It varies to the amount of your charged balance. It has a maximum allowed, or credit limit. The payment is calculated based on the interest rate and current balance in any 30 day cycle. Understanding the difference will be important in helping you assess your credit profile. A mortgage loan in most cases is an installment loan. We will discuss revolving mortgage accounts or lines of credit later in the book.

It is easier to obtain a copy of your credit report today more so than ever before. I recommend that everyone take advantage of the free options available. Periodically checking on your credit file helps to ensure no one is fraudulently using your credit information. You will be able to see what trade lines (companies) are reporting to your credit file. Any liens or judgments that may have been filed against you will report. If you have ever filed a bankruptcy, that information is public record and reports to all three of the major credit reporting agencies in the country. Medical collections can also be seen. It is important for you to know what information lenders are reviewing in order to make a lending decision based on your loan request.

Most companies report their loan records to credit reporting agencies. Utility companies and some smaller institutions such as credit unions, may not report. Lenders typically review the last twelve months of your payment activity. They will look to see how many late payments you have had during that time. What a lender considers late, and that which is reported, is greater than 30 days past due. For example, if your mortgage payment is due on June 1^st, it would report as 30 days delinquent as of July 2^nd. Many people juggle which payments to make within their monthly budget. I strongly recommend that you pay your bills in this order: mortgage, other installments (car), revolving, medical, and collections last. Let me explain why.

A collection account is one that reached a point of default where the lending institution writes it off as a loss. Other collection agencies by the “paper” or loan and begin to make collection efforts to make their money. Most collection agencies will settle for a lesser amount if negotiated properly. Because the debt has already reported to the credit bureaus as a charge off or loss, the damage is done. The collection agencies may report the debt again on your credit report. Paying that last makes sense. Focus on maintaining what is most important, shelter and transportation. Your consistent payments efforts are what lenders call, a history. Having a history of late payments tells a lender that you will probably pay late in the future. Therefore, they price your loan higher for that risk. A proven payment record gives the lender confidence you will pay your loan back on time. You have a proven history of payments.

Consider how many trade-lines you have reporting and what the high credit limits are. If you have open revolving accounts and you are not using them, close them. This is important because from a lenders perspective, that is less available credit. A lender considers what your capacity for additional debt could be. If utilized, it could affect your current ability to pay. We will discuss your ability to pay in the debt to income section. Having revolving credit cards with high credit amounts tells a lender you could choose to charge that much. If the account is closed, the trade-line will only report the history of your payments, but show you no longer have access to additional debt. You can’t charge any more.

If you decide to co-sign for someone, recognize that the loan will affect your personal credit. It will report on your credit file just as your own debt would. If the person you co-signed for doesn’t make the payments on time, it will report as delinquent debt and can damage your credit. I am sure you have all heard about your credit score. It is a scoring model to help lenders assess credit and the risks involved with each consumer. Most models consider the higher your credit score, the better your credit worthiness. There are several different models, the most common is FICO. There are thousands of factors that affect your FICO score. A credit inquiry is one of them.

When you fill out an application for a loan, it reports as an inquiry. An application is almost automatically followed by the lender “pulling” your credit report. That means they must assess your credit history and allow the lender to make a lending decision. The inquiry will report whether or not you are approved for the loan you were applying. A lender considers credit inquiries with an implied risk. The more you are “shopping” the more credit exposure you could take on. If you have multiple inquiries, but no resulting trade lines, that is another inherent risk associated with your credit profile.

A thin credit file is not always good because it doesn’t establish an ability to pay. If nothing reports to your credit file the lender has no way to know how you will pay in the future. It is important to establish credit trade-lines even if you don’t need to. For example, if you have an option to purchase a large appliance on a same as cash option, take it. It will report as a trade-line and allow you to make monthly payments. You may be able to afford to pay cash, but if you need to build a credit file, this is a great way to start. As well, applying for credit cards is not a bad thing. Having one or two cards that you can use, but can afford to pay off monthly, will help you to establish a history of credit and payment activities.

In summary, a lender will review your entire credit profile when making a lending decision. You represent low risk when you have made all your payments on time and don’t have too much debt available to you. On the other hand, you are a risk if you have shown an inability to make consistent monthly payments or have allowed a debt to be written off as a loss. Bankruptcies are a whole story in themselves that will not be addressed in this publication. Finding a way to handle debt and pay it off in half the time is what United First Financial can do. Be mindful of the damage a late payment can have on your ability to qualify for a loan or get the best rate available. Your history will determine your future.