As banking professionals it is important to educate current or potential applicants, referral sources, and your customer base on the factors that affect a successful closing. Since banks have raised their thresholds for what is average, good, and great credit, many transactions have either failed due to lowered credit scoresor consumers wind up paying much higher premiums for loan approval. When borrowers learn they may pay over $100,000 to $500,000 more, and in some cases millions, for a loan due to lower credit scores they realize how important knowledge of credit and the value of great scores can be. If an applicant is borrowing $700,000 through a Fannie Mae loan and they have a 660 to 739 Fico score they may have to come up with $19,250 in points at closing (a point is 1% of the loan) or pay a 5% interest rate over the loan term. If the buyer had a 740 plus Fico credit score they would not have to pay any points and the rate could be 4%.

Let’s say they don’t have the additional $19,250 to buy the rate down that extra 1% what would happen?

Buyer A has a 660 credit score and pays 5% interest on the $700,000 loan. Over 30 years the cost would be $1,352,796.

Buyer B has a 740 plus credit score and pays a 4% interest rate on the $700,000 loan. Over 30 years it will cost him $1,203,094.

THE SAVINGS WOULD BE  $149,702!!

Most consumers would be very happy to have a banking professional who prompts them early on to check and improve their credit so they can have the opportunity to enjoy these huge savings.    

To have great credit scores we must understand the factors that the Fico formula uses to tabulate a score:

1.            Payment History

2.            Amount of debt

3.            Length of credit history

4.            New credit

5.            Types of credit used

Today we will focus on payment history and the next four Newsletters we publish will focus on each of the other factors. Payment history weighs heavily on Fico credit scores. Since a bank may be supplying a borrower with hundreds of thousands of dollars, possibly millions, it is crucial to know how that applicant has managed his payments in the past with other creditors, as the past is a great indication of what the future might hold. When the lender views the credit scores and reports they can see the payment history for what could be a 7-50 year period depending on the age of the applicant. Negative information which includes late payments, judgments, tax liens, collection accounts, charge offs, repossessions, settlements, short sales, foreclosures, child support, debt consolidation programs, and some loan modifications can remain on credit for up to 7 years and in some cases (including bankruptcy) even longer. Although most negative information remains on credit for 7 years from the date it occurs what happens in the past 2-4 years has the greatest impact.

Here is an example:

John had a bankruptcy five years ago and enough time has gone by for him to be eligible for loan approval. He has been working hard with us over the past few years to clean up his credit and build good history. John has four excellent credit card accounts he opened four years ago and his current Fico score is a 720. John will be approved for a loan at a 5% interest rate.

Lisa is getting ready to purchase a property in NYC and will need loan approval for over a million dollars. When asked by the realtor how her credit scores were she stated, “They should be great”. The realtor suggested Lisa meet with a banker to get a pre-approval letter so they can begin shopping for a property. Lisa meets with the banker and is shocked to find out that her FICO score was a 650. Lisa had a thirty day late payment last month with a credit card for $15.00. Although Lisa was on time with all her other accounts, because the late payment occurred so recently her credit score dropped 90 points. She was amazed to find out it is not the amount of the late payment that affects the credit but the timing of when it happens. While Lisa earns over $500,000 a year and has great savings and investments, it didn’t matter much to her score, as her credit is only showing the bank what her payment patterns are. The score cares little if the late payment was $15 or $50,000. Lisa cannot even get loan approval with this poor credit score.

Luckily for Lisa we were able to remove the late payment from her credit and she will be ready to get approved once she finds the right property. Lisa was fortunate to learn early on in the process that her score needed work and we were able to help her.

New negative credit is much more damaging to credit scores since it has to reflect to the score that this consumer is a much higher risk borrower. Since statistics show that the majority of consumers with new late payments and delinquencies wind up defaulting, the score has to reflect the new higher risk category to the lender. How it works is the higher your credit score the more it has to dip after a delinquency to reflect the risk change. For example, with an already poor Fico score at 590, a new late payment might drop the score an additional 10-15 points; whereas, an exceptional 780 Fico score would have to drop 100 points to bring the risk level up substantially. A 680 is the lower end of good. So it is very possible that a consumer with a bankruptcy 5 years ago can have a better score than one with new late payments.

Feel free to call us with any questions or feedback on credit challenged clients or credit in general!

In two weeks we will discuss AMOUNT OF DEBT and how it affects credit scores.

Making sure credit is analyzed with future financial goals in mind is a MUST before taking an action that can foil those plans and limit a consumers options for a better quality financial life.