Saturday May 20, 2017
 
Credit rating guide can help you avois the pitfalls of dealing with your credit

Credit Rating Guide

This credit rating guide guide will help you assist you in assessing your potential credit grade and what type of terms you can expect from a mortgage lender.

Keep in mind this is merely a generic guide as some mortgage lenders have different grading based upon their own process of valuation.

Credit

The credit is broken into three primary classes:

  1. Mortgage Credit - Your payment history on your active, or past mortgage loan.  Your previous repayment history on mortgage debt will be a solid indication of a borrowers attitude toward his/her mortgage responsibilities.  Payment history on mortgage debt is very crucial in deciding your credit score.  This obviously concerns persons who have owned a home sometime in the past.
  2. Public Records - The second class relates to public records such as prior bankruptcies, collections, tax liens, foreclosures and judgments.  "A" borrowers generally cannot have a bankruptcy within past 10 years.  The "C" borrower could conceivably still be in foreclosure or bankruptcy at the time of closing.
  3. Consumer Credit - This class pertains to revolving and installment credit. Installment credit covers long term credit with structured payment programs, such as auto loans or student loans.  Revolving credit covers department store (Gap, Macy's, Best Buy, etc.) and bank credit cards, such as (MasterCard, Visa, Discover, etc.).  Normally, payments received thirty days past the due date are shown as a late in your credit report.  This will affect your credit score substantially.

The bigger the credit problems, the further the score decreases (see below).  As the credit scoring on loans decreases, mortgage lenders typically assess higher interest rates and fees.

Max LTV also known as Loan-to-Value

LTV as it's generally referred to, is the ratio of mortgage loan amount to the appraised value of a property.  For instance, a loan of $200,000 on a property valued at $400,000 has a LTV of 50%.

The closer your LTV is to 100%, the tighter the mortgage lenders become on credit and debt ratio.  Prior to 2008 "A" borrowers could get 100% LTV loans and in some cases even 125% these have become almost non-existent even for borrowers with the best of credit.  For the "D" borrower maximum loan-to-value ratio is often much lower than 80%.

Debt Ratio

In addition to credit considerations, mortgage lenders will review the capability of borrowers to repay their mortgage obligation.

Mortgage lenders calculate the debt ratio by dividing the total monthly debts (the housing expenses for the proposed mortgage loan plus the borrowers other monthly credit obligations) by the total gross monthly income.

For instance, if total obligations for the borrower are $2,800 ($2,000 for the mortgage, taxes and insurance and $800 for all other credit responsibilities), the debt ratio would be 35% ($2,800/$8,000 = 35%).

If a borrower has a low debt ratio, the grading will be higher.  Conversely, if a borrower has a high debt ratio, the grading will be lower.

Credit Score

Mortgage lenders and other creditors oftentimes use credit scores, called FICO scores, to decide the credit risk.  The higher the credit score, the better the credit risk.

FICO stands for Fair Isaac Company, the company that created the original credit scoring system.  All three credit bureau's have its own unique system which lets them offer a score supported entirely on the contents of the credit bureau’s data about an individual.

Even so, a numerical score at one bureau is the same as the numerical score at another.  Therefore, a score of 720 from Experian indicates the same creditworthiness as a score of 720 from Equifax or Trans-Union, even though the calculations used to decide those credit scores are different at each bureau. 

The scores range from 400 to 900 points, and generally, a score of 680 or above suggests a good credit history.  Average FICO scores fall into a range between 650 and 680.

It must nevertheless be mentioned that not all mortgage lenders give the same value to all credit scores.  Also, not all mortgage lenders use the credit scoring system and even when they do they might not use the credit scoring system for every loan program they have available.  Many small community banks still do this.

The rate of interest a mortgage lender will charge hinges upon these four factors.  If all the factors are great, the mortgage loan is assigned an "A" grade and consequently qualifies for the best rate of interest.

If even one of the factor is not up to par, the quality of the loan is downgraded to A-, B, C, or D paper.  "D" paper pertains to what is called hard money mortgage loans which are largely based on the amount of available equity in your property and not just on your credit.

"A" paper mortgage lender's who are making a B, C or D paper mortgage loans are taking a much higher risk because there's an increased likelihood of the mortgage loan defaulting.

The mortgage lender is compensated for the higher risk by giving the borrower a higher rate of interest and making a higher rate of return:

  1. "A" paper could have rates 0.50% - 1.50% above "A" paper rates
  2. "B" paper could have rates 1.50% - 2.75% above "A" paper rates
  3. "C" paper could have rates 2.75% - 4.00% above "A" paper rates
  4. "D" paper could have rates 4.00% - 7.00% above "A" paper rates

The interest rates quoted for A-, B, C, D paper can vary immensely from mortgage lender to mortgage lender.  ARM programs, for instance are notorious for having huge discrepancy in rates from mortgage lender to mortgage lender

Below are some of the typical requirements used by many mortgage lenders, but are not absolute credit grades - mortgage lenders normally have similar, but slightly different specs.

Grade Credit Score Debt Ratio Max LTV Delinquencies
within last
12 months
Credit Bankruptcy / Foreclosure
Mortgage Installment Revolving
A to A+ 680+ 28-31 95-100 30 days 0 0 1 Good/excellent credit during last 2-5 years. No mortgage lates within 24 months. No bankruptcy within the last 2-10 years.
60 days 0 0 0
A- 660 35 95 30 days 0 1 1-2 No 60-day mortgage lates.  Minimum 24-48 months since bankruptcy discharge.
60 days 0 0-1 0-1
B 620 41 75-85 30 days 1 2-4 3-5 24-48 months since bankruptcy discharge. Re-established credit.
60 days 0-1 1-2 1-2
C 580 48 75 30 days 2-3 4-6 5-7 12-24 months since bankruptcy discharge.
60 days 0-2 2-4 3-5
D 550 55 65-70 60 days 1-3 5-7 6-8 Bankruptcy discharged within last 12 months.
Poor payment record with limited 90 day, isolated 120 day lates.
E 520 65 50-65 Poor payment record with a pattern of 30, 60 and 90+ lates Possible current bankruptcy or foreclosure.  Stable current employment.

 

Note: The numbers presented here are broad guideline and could change from mortgage lender to mortgage lender.  Exceptions are possible with substantial compensating factors that reflect you are a low credit risk.

A few compensating factors are long-term job stability, history of savings, history of making monthly credit payments that equal or surpass the planned payments, a large down payment or a large cash reserve after the close of escrow.

If you plan on shopping around for a mortgage we propose that you take the time to order your credit report from all three credit agencies use what you have learned from this credit rating guide and check it for errors.

The 3 leading credit reporting agencies are:
Experian    Equifax    TransUnion

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