Credit scores have a huge impact on our lives. If you are
going to borrow money for a car or a home, the scores on
your credit report will help determine the loan amount
granted, and more importantly, the cost of your loan in
the form of interest rates and fees.
A while back, I went to a seminar where some of the
behind-the-scenes information was discussed.
First, some basics.
Credit scores range from 300-850 (some models may go to
900).
On the credit report, the top 4 reasons are listed as
to why the score is not perfect.
Originally, Fair, Isaac was asked to produce a model
that would predict the likelihood of a borrower having
a 90-day late in the next 24 months.
It is a dynamic modeling system, representing a moment in
time. The score can be different in the morning and afternoon
of the same day.
The model is weighted by the following factors:
35% of your score is based on history.
If there are lates, the model looks at recency, frequency,
and severity.
Recency:
There is a heavy impact if the late is within the last 6 months.
There is moderate impact if the late is within the 7-24 month
range.
There is little impact if the late is over 24 months ago.
Frequency:
Obviously the more often accounts are late, the more impact
on scores.
Severity:
The longer the late, the more impact on scores. For example
a 30-day late is less costly than a 60-day late which is less
costly than a 90-day late, etc.
Late payments and inquiries after a bankruptcy can be
costly to the score.
30% of your score is based on level of debt.
Higher credit card balances are an indicator of higher
likelihood of default.
Limited use of lots of available credit is favorable.
Don't close credit cards. This tends to skew your report
toward more recent credit and you lose the benefit of the
history of the old cards that will be closing.
Using cards to their maximum credit limit is less favorable.
Pay them down, spread the balances to existing cards,
or ask for increases to the credit limits.
Use 2-5 cards actively, meaning at least every 3-6 months.
HELOCs are scored as installment debt if the balance is
more than $30,000. This is more favorable in the credit
model. They are scored as revolving debt if less than $30,000,
and this is less favorable in the credit model.
15% of your score is based on length of credit history.
The model looks for a 30 year history.
Rotating revolving debt to new credit card at a high
balance-to-limit ratio works against the score. And,
as we said, closing the old card makes the credit history
look shorter, and does not score as well.
10% of your credit score is based on credit mix (open and
closed accounts).
Revolving debt has the most negative impact.
Finance company references hit the score the hardest.
Deferred payment accounts can be a problem. If you ever
make a payment on one before you have to, continue to
make even a small payment because the reporting system
is now activated to show it as a paying account, not a
deferred account. If you don't continue making even a
small payment, you will probably be reported with lates.
These deferred payment accounts also will report a high
balance on the report based on the add-on interest, and
will also show the inquiry. These are not invisible to the
credit report!
10% of your score is based on inquiries.
Inquiries stay on your report 2 years, they count in the
scoring for 1 year, and they actually show on your report
for 90 days.An inquiry can count for 2-15 points against
your score.
Companies can no longer run your credit without a signed
authorization.
Inquiries from auto companies within a 7-day period are
grouped as 1 inquiry.Inquiries from mortgage companies
within a 30-day period are grouped as 1 inquiry. Rolling
14-day inquries are considered as 1 inquiry. (Theoretically,
you could run the credit every 14 days for a mortgage and
have it only count as 1 inquiry).
Credit union inquiries can't always be determined: they
may be revolving (credit card), installment (auto), or mortgage.
Some statistics:
Median score is 720.
11% had a score >800 and had a default rate of 1%
29% had a score of 750-799 and had a default rate of 2%
20% had a score of 700-749 and had a default rate of 5%
16% had a score of 650-699 and had a default rate of 15%
11% had a score of 600-649 and had a default rate of 31%
7% had a score of 550-599 and had a default rate of 51%
5% had a score of 500-549 and had a default rate of 71%
1% had a score of <499 and had a default rate of 87%
As we take a look at the mortgage meltdown through the
prism of credit scoring we can see that even if there
were not a decline in property values, that the lenders
were putting themselves in a very vulnerable position.
Many programs allowed for scores of 640 or less, and they
allowed financing up to 100% without documenting income.
Statistically, they had a 40% to 87% chance of default
before accepting the additional risks of high loans in
relation to the value of the home, and accepting the
borrowers' representation of their incomes!
Use these guidelines as you make decsions about your
credit activity. Remember that the credit bureaus have
created these "black box" modeling systems and that the
process is not transparent.
Be sure to do adequate research so that if you decide to
apply for credit, pay off some credit items, or close
accounts that you feel comfortable with the potential
consequences to your credit score.
Wednesday, September 24, 2008
Wednesday, September 10, 2008
Keeping Your Existing Home When Buying A New Home
There are times when a borrower wants to buy their new
home, but want to or need to hold onto their existing
home and use it as a rental property.
In the current market, there are many homeowners who
owe more on their homes than they are now worth. Also,
they see that they could buy a comparable home to the
one that they own for a much lower purchase price.
What has developed recently is that some homeowners
found a solution to their problem that the lending community
didn't anticipate.
Before they developed credit problems on their existing
home loans, they would purchase a new home. As part of
the qualifying for the new home, they would represent
that they would rent out their existing home and move
into the new one.
The underwriting guidelines that were in place allowed
a portion of the rental income to offset the expenses
on the soon-to-be-rental property. Specifically, 75%
of the rental income was allowed to be used. The guide-
lines recognized that there would be vacancies and
maintenance costs which is why they did not allow the
full rental income.
These homeowners were able to buy their new home at a
signicantly reduced price compared to what they paid
for their existing home. After closing, and recognizing
that there was no advantage to them keeping and main-
taining the home they just departed, let that home
revert back to the lender through default and fore-
closure.
At that point, their credit becamed impacted, but because
they had already purchased their new home that they were
planning on living in for quite some time, the bad credit
that developed didn't keep them from reaching their goal.
Because this became a significant trend, there are now
new underwriting guidelines for retaining the existing
home and purchasing a new home.
1. If the current primary residence is pending sale but
will not be closed prior to the closing date of the new
primary residence, the borrower will have to qualify for
both the current and new mortgage principal, interest,
taxes and insurance amounts (PITI). No potential
rental income offset will be allowed.
2. If the current primary residence will become a second
home and there is at least 30% documented equity in the
current home, the borrower will have to qualify for both
the current and new mortgage principal, interest, taxes
and insurance amounts. This requires that there are at
least two months of PITI for both properties.
3. If the current primary residence will become a second
home and there is not at least 30% documented equity in the
current home, the borrower will have to qualify for both the
current and new mortgage principal, interest, taxes and
insurance amounts. This requires that there are at
least six months of PITI for both properties.
4. If the current primary residence will become a rental
property and there is at least 30% documented equity
in the current home, they will allow the 75% of rental income
to offset the expenses on the existing home. No longer
can the borrower merely represent the proposed rental
income, though. They would require a fully executed lease
agreement and proof that a security deposit was received
from the tenant and deposited into the borrower's account.
5. If the current primary residence will become a rental
property and there is not at least 30% documented equity
in the current home, the borrower will have to qualify for
both the current and new mortgage principal, interest, taxes
and insurance amounts. This requires that there are at
least six months of PITI for both properties.
To document the existence of the the 30% equity position,
the borrower would have to provide a full appraisal of the
existing home.
The lenders are hopeful that by instituting these changes
that they will prevent or slow down the number of borrowers
who buy the new home and then send the keys back on the
old home.
If a borrower has little equity in the home, but have the
financial capacity to qualify for the expenses on both
homes, the lenders are thinking that they will not be as
tempted to damage their credit for the future.
If a borrower has a lot of equity in the home, they are
more willing to allow the rental income offset, because
it is much less likely that the owner will sacrifice 30%
or more of the equity of the home by defaulting. They
would probably sell the home in the open market before
letting the lender take it back.
This is further evidence that the underwriting guidelines
are attacking every element of the process that they
can identify as having contributed to losses or fraud.
I always say it, but it bears repeating: You have to plan
ahead and start the conversation about what you are trying
to accomplish before you get involved in that new trans-
action.
Underwriting guidelines are more restrictive than at
anytime in recent memory, and they are changing
constantly.
Do not rely on old information or anecdotal stories from
your friends and co-workers.
Call me so that we can deal with your specific facts and
your unique qualifications.
home, but want to or need to hold onto their existing
home and use it as a rental property.
In the current market, there are many homeowners who
owe more on their homes than they are now worth. Also,
they see that they could buy a comparable home to the
one that they own for a much lower purchase price.
What has developed recently is that some homeowners
found a solution to their problem that the lending community
didn't anticipate.
Before they developed credit problems on their existing
home loans, they would purchase a new home. As part of
the qualifying for the new home, they would represent
that they would rent out their existing home and move
into the new one.
The underwriting guidelines that were in place allowed
a portion of the rental income to offset the expenses
on the soon-to-be-rental property. Specifically, 75%
of the rental income was allowed to be used. The guide-
lines recognized that there would be vacancies and
maintenance costs which is why they did not allow the
full rental income.
These homeowners were able to buy their new home at a
signicantly reduced price compared to what they paid
for their existing home. After closing, and recognizing
that there was no advantage to them keeping and main-
taining the home they just departed, let that home
revert back to the lender through default and fore-
closure.
At that point, their credit becamed impacted, but because
they had already purchased their new home that they were
planning on living in for quite some time, the bad credit
that developed didn't keep them from reaching their goal.
Because this became a significant trend, there are now
new underwriting guidelines for retaining the existing
home and purchasing a new home.
1. If the current primary residence is pending sale but
will not be closed prior to the closing date of the new
primary residence, the borrower will have to qualify for
both the current and new mortgage principal, interest,
taxes and insurance amounts (PITI). No potential
rental income offset will be allowed.
2. If the current primary residence will become a second
home and there is at least 30% documented equity in the
current home, the borrower will have to qualify for both
the current and new mortgage principal, interest, taxes
and insurance amounts. This requires that there are at
least two months of PITI for both properties.
3. If the current primary residence will become a second
home and there is not at least 30% documented equity in the
current home, the borrower will have to qualify for both the
current and new mortgage principal, interest, taxes and
insurance amounts. This requires that there are at
least six months of PITI for both properties.
4. If the current primary residence will become a rental
property and there is at least 30% documented equity
in the current home, they will allow the 75% of rental income
to offset the expenses on the existing home. No longer
can the borrower merely represent the proposed rental
income, though. They would require a fully executed lease
agreement and proof that a security deposit was received
from the tenant and deposited into the borrower's account.
5. If the current primary residence will become a rental
property and there is not at least 30% documented equity
in the current home, the borrower will have to qualify for
both the current and new mortgage principal, interest, taxes
and insurance amounts. This requires that there are at
least six months of PITI for both properties.
To document the existence of the the 30% equity position,
the borrower would have to provide a full appraisal of the
existing home.
The lenders are hopeful that by instituting these changes
that they will prevent or slow down the number of borrowers
who buy the new home and then send the keys back on the
old home.
If a borrower has little equity in the home, but have the
financial capacity to qualify for the expenses on both
homes, the lenders are thinking that they will not be as
tempted to damage their credit for the future.
If a borrower has a lot of equity in the home, they are
more willing to allow the rental income offset, because
it is much less likely that the owner will sacrifice 30%
or more of the equity of the home by defaulting. They
would probably sell the home in the open market before
letting the lender take it back.
This is further evidence that the underwriting guidelines
are attacking every element of the process that they
can identify as having contributed to losses or fraud.
I always say it, but it bears repeating: You have to plan
ahead and start the conversation about what you are trying
to accomplish before you get involved in that new trans-
action.
Underwriting guidelines are more restrictive than at
anytime in recent memory, and they are changing
constantly.
Do not rely on old information or anecdotal stories from
your friends and co-workers.
Call me so that we can deal with your specific facts and
your unique qualifications.
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