FICO

Not too long ago, the credit world was much different than it is today.  Credit bureaus operated in near secrecy, gathering information in ways that may surprise you.  For instance, did you know that Retailer’s Credit (now Equifax) received information about you gathered by the Welcome Wagon hostess?  Your credit worthiness may very well have been based on things such as the quality of your home furnishings and the Welcome Wagon hostess’ opinion of your character.

For the consumer, trying to see what was in your report was nearly impossible.  It could be full of errors and inaccurate information and you’d never know!  Let’s face it, even if you knew about it you couldn’t get it corrected.  Even today, many customers we work with are surprised when we offer to send them their report so they can review it.

Lending decisions in the past were made partly on the content of that report, but mostly on the whim of the underwriter at the bank you were applying at.  This process was very subjective and not very fair.  If you didn’t “look right” or were stereotyped by ethnicity, neighborhood, or profession, you may have been denied credit solely on that information alone.

This started to change slightly in the 1960’s when credit cards became popular.  There was no way to personally interview an applicant who lived states away from the issuing bank, and as we pointed out previously, the information in the credit reports that were available was not very reliable.  Many disastrous lending decisions were made using the information in those reports.

During this same period Congress had begun investigating discrimination in housing loans and the practices of collection agents.  The result was the FCRA, enacted in 1971 and later the FDCPA in 1977.  The FCRA literally forced Credit Reporting Agencies (CRA’s) to clean up their act.  As the data in consumer reports became more standardized and more accurate, lenders began to rely more on the reports and less on the underwriters’ subjective opinions.

Lenders then began to develop their own automated risk-scoring, but the results were inconsistent and inaccurate.  They often still factored in things like age, gender, race, familial status, etc.  The system was headed in the right direction, but still broken.

Fair Isaac and company capitalized on this new movement and on the push to reform mortgage lending by compiling their risk model scoring.  Finally released in the 1980’s, it was touted as an impartial, consistent way to evaluate credit applications and was developed to take the prejudice and instinct out of the equation.

Given that Congress was pressuring lenders to eliminate discriminatory lending practices, FICO seemed like the answer to their dilemma.  They jumped on it and have never really looked back.  Most lenders employ their own internal risk calculation, of which FICO is only a portion.
FICO has been accused over the years of factoring race, age, and gender into their equations, but the most common complaint is that of zip-code discrimination.  In a historical sense, however, FICO did wonders to level the playing field.  Not until very recent years could a consumer see their credit score – a remnant of that old secrecy pact.  California’s SB1607 was the first law to mandate consumer disclosure of scores in 2000!

We would not need credit had it not been for Edwin.

Years ago in the early days of our country settlers moved to various parts of the country.  As the population grew, they set up businesses, normally a general store, a tavern, and later – a bank.  General stores at the time would often extend credit to the community, people purchasing what they needed while the store keeper kept track with a pencil and paper.  As those people brought their goods to market to sell, they’d return to pay off the store keeper.

Everyone except Edwin, that is:

At some point, now lost to history, the merchants in some town all gathered for a morning coffee klatch to discuss business. The owner of the general store mentioned Edwin and how he hadn’t paid off his bill last month.  The livery owner chimed in with a similar experience.  The other store owner’s hadn’t dealt with Edwin yet, but they’d make a note that Ed was to be cash-only should he stop into their establishment.  Edwin then became the first settler to officially have bad credit.

The shop keepers began to see value in sharing information and agreed to keep notes on who they were having trouble with.  Additionally, they agreed to meet every so often and share that information.  Eventually the list grew longer and needed to be written down.  Thus, the first credit report was born.

The origins of credit reporting were keeping track of negative experiences only; those who paid late or did not pay at all, a tradition that stuck with credit reporting for years and still has a strong influence on it credit reporting today.  As the settlements grew into cities, these informal meetings became more organized, eventually taking the name “Mutual Protection Societies.”  Mutual Protection Societies was the forerunner of CRA’s as we know them today, organized to keep track of people who had burned a merchant.

Time progressed and people like Edwin became more mobile.  It wasn’t hard for someone with a bad reputation to pick up and move to the next town.  To combat this, the Mutual Protection Societies began to join together and cover larger territories.  Now if Edwin wanted to escape his past he had to move to an entirely different geographic area.

One of the large Mutual Protection Societies was Retailers Credit in Texas, which covered the southern part of the country keeping information on consumers in “files” which consisted of a ledger sheet in a file carrying the consumer’s name.  Retailers Credit eventually changed their name t o Equifax and began branching out to the west.

The Union Tank Car Company of Chicago, a railroad leasing company, purchased the Credit Bureau of Cook County in the late 1960’s and it’s approximate 4 million ledger-card files contained in 400 seven-drawer filing cabinets.  Thus, TransUnion was born and was the first to pioneer tape-based data storage allowing it to branch out and cover larger territories without the need for branch offices.

Meanwhile, TRW, formerly Thompson Ramo Wooldridge Inc., had jumped into the credit reporting business.  TRW was the first to provide credit data on demand by electronic, real-time means.  This propelled TRW to the top of the heap, becoming the largest repository of credit information in the world.  Edwin’s days of hiding from his past were over.  TRW had the ability to store data on anyone regardless of geography and provide it to anyone, anywhere, within a matter of hours.

TransUnion stuck mostly with it’s original mission of keeping credit-related data only while Equifax, and to a lesser extent, TRW had compiled additional personal data and opinion, character reports, as well as commentaries from neighbors and insurance agents.  Talk about an unregulated industry gone wild!  It was truly a “consumer report” that Equifax provided, containing much more than mere payment history.

Secrecy was tightly kept, lenders were not allowed to disclose the content of a consumer’s file to the consumer.  Violators were dealt with harshly, resulting in a denial of access to any further reports and occasionally lawsuits over confidential trade information rights.  The CRA’s refused to make consumer disclosures.  You did not know what was in your file and could not correct any errors.  The CRA’s were an industry without regulation and consumers began to fear them, realizing the unchecked power that they were amassing.

As previously mentioned, Congress stepped in with the FCRA in 1971, regulating and standardizing the information in consumer reports.  Consumers were finally allowed to see their reports and dispute errors therein.  As light was shed on the CRA’s practices, they began to clean up their formerly secretive and sometimes abusive acts.

Ever wonder why creditors are allowed to see other inquiries made for your credit report?  In the early to mid 1970’s there was a television commercial selling a “get rich quick in real estate” package.  To get rich quick, a customer would apply for 10-20 credit cards all at once.  Since inquiries were not reported publicly lenders had no way of knowing that their customer had applied all over town.  Someone with an income capable of supporting $5,000 in credit could grab $60,000 in credit in a day.  They could then cash out the cards, buy a piece of property, sell it quickly (flip) and pay off the cards.  They could repeat this process until they ran into a property that did not sell.  No joke!!

The huge default that followed got the attention of lenders who pushed for the right to see inquiries on credit reports to prevent such exposure.  That marked the end of the television commercial and instituted the practice of inquiries being taken into consideration in lender’s internal risk model scoring.

Lending A Hand

Marla Wynn

The Wynn Team

Bonnie and Clyde (fictional names, of course) called us up the other day to get qualified for a home purchase.  Apparently the robbery profession isn’t what it used to be.  Anyway, we started through the questions to complete a pre-qualification, including:

• Legal Name
• Home Address
• Current Employer
  • Job Title
  • Length of Time with Employer
• Income
  • How Often Pay Received
  • Type of Pay
    • Hourly/Salary
    • Bonus
    • Overtime
    • Commission
    • Self Employment
    • Etc
• Assets
  • Checking
  • Savings
  • Investments
  • Retirement
  • Gifts (from relatives)

Once this information was gathered we had a couple of choices:  we could run a credit report to see what the score looked like or we could discuss the debts as Bonnie and Clyde knew them.  In this case Bonnie and Clyde decided to run the credit report to so we could a listing of all of their debts as well as the scores.  Here is how it turned out:

Bonnie

• 563 Experian
• 581 TransUnion
• 593 Equifax

Clyde

• 536 Experian
• 544 TransUnion
• 538 Equifax

Our most recent post discussed the representative score for a mortgage.  In this case the representative score would be a 538.  538 credit score is not sufficient to qualify for A-Paper mortgage options so we discussed Bonnie and Clyde’s options with them:

Options When One Borrower’s Scores are Higher than the Other:

1. Remove the borrower with the lower score

By removing the borrower with the lower credit scores you can effectively increase the representative score for the loan.  In this case, if we removed Clyde, the representative score would go from 538 to 581 (removing Clyde removed the lower of the two representative scores so now we just go with Bonnie’s)

2. Change borrowers

In some cases there are opportunities where we can remove a borrower with a low credit score and use another person who will be occupying the home. An example we see commonly is multi-generational families living together. If the husband and wife are looking to purchase with the husband’s mother, we now have 3 borrower options (husband, wife and mom). If say, husband can not qualify due to credit scores, mom may be added to the loan in place of the husband.

3. Work to increase the credit score(s)

Although this is the hardest option which typically takes longer than the other options this is the option most customers must opt for because the other options are not available to them. In a situation like this your mortgage lender may have options to assist you in methods to increase your credit score. If not, you may also seek out a credit repair company to assist you (BEWARE: some credit repair companies are nothing but scams to take money from people in desperate situations so do your research or get a referral).

In our case, Bonnie made the majority of the income so removing Clyde was an option that worked well since at the time we assisted Bonnie and Clyde the minimum credit score required was a 580.  When you remove a borrower from the loan their income is removed too.  This is why in Bonnie and Clyde’s situation, Bonnie making most of the money and having the higher score worked to their advantage.

Credit Requirements (Not Just Credit Score)

When we looked at Bonnie’s credit we not only needed to make sure she met the credit score requirement at the time (580) but we also needed to make sure she met the credit requirements for the loan in which she was applying.  Bonnie was interested in FHA financing due to it’s lower down payment, lower monthly payment and easier qualifications.  Each situation is different so there is no way to list the exact qualifications that must be met but for a general idea of what FHA requires check out our post about FHA Mortgage Loan Requirements.

Bonnie did meet the credit requirements and from the initial questions her qualifications looked good.  The next step was to complete the pre-approval process.

Lending a Hand

Scott Wynn

The Wynn Team

Photo provided by Sarah McClain on Flickr

We received a couple of calls in the past few days for potential home buyers looking to get qualified for a mortgage and both of them had questions about how Mom and Dad could help them qualify. Here are their situations:

#1 – Can a Co-Signer Help a Borrower with Low Credit?
Bert (fictitious name to preserve anonymity) emailed us looking to get qualified for his first home purchase. The email went something like this:

I’m looking to buy an inexpensive, first home and I know I need to get qualified for a mortgage.  I know my credit isn’t great but I do have some money for down payment.  Can you help?  Call me XXX-XXX-XXXX.

After receiving this email I picked up the phone and called Bert to see how I could help him out.  We started talking about what he was looking for.  We talked about the type of houses he was interested in and the problems he felt might stand in his way from getting qualified for a mortgage – credit.  He stated that his credit was horrible with late payments and probably some collections.  He wasn’t quite sure of his score but knew it wasn’t good.  He shared he was employed with a good income and enough money for down payment.  He also shared that his Mom would be willing to co-sign.

Can I qualify?

When it comes to qualifying for a mortgage credit is the one area that all borrowers must qualify independently.  The reason is because of the mortgage guidelines for credit.  The guidelines specifically state:

the representative credit score for a borrower is the middle of the 3 scores, lower of the 2 scores or the only credit score provided from a tri-merge credit report

AND

the representative score for a mortgage loan is the lowest of the borrowers’ representative scores

Let’s look at a hypothetical example:

Borrower #1

• Experian = 650
• Equifax = 672
• TransUnion = 665

Borrower #2

• Experian = 708
• Equifax = 719
• TransUnion = 703

In this example, Borrower #1’s representative score is the middle of the 3 scores (650, 672, 665) or 665.  Borrower #2’s representative score is 708.  To determine the representative score for the mortgage loan we take the lowest of all the borrowers’ representative scores (665, 708) or 665.

Based on this example and an understanding of the representative scores, you can see how one borrower with a low score can impact the qualifying of a mortgage negatively.  Getting back to our customer and to answer his question about whether a co-signer would help his situation – the answer is no.  If the minimum credit score for a mortgage loan today is, say, 580 and he has a 450 but the co-signer has an 850, the representative score would be 450, not allowing him to qualify for a mortgage even with a co-signer.  So, what solution do we have in a situation like this?  Mom could buy the home as an investment property (meeting all of the down payment, credit score, income and asset requirements for such a loan) and then rent the property to her son.  What about a higher down payment? Although the typical A-Paper mortgage options (FHA, VA and Conventional mortgages) other mortgage options may exist for such a situation, but since that is not my area of expertise I can not comment.

#2 – Mom and Dad are Willing to Help Me Anyway they Can…

The next customer, let’s call him Ernie, was also looking to make his first home purchase but he didn’t have a problem with credit, but just about everything else.  He had a credit score sufficient for qualifying, a part-time job with a little income, and a checking account with a small amount of assets.  Putting all of this together he would qualify for a mortgage but not within the price range he was hoping for.  He mentioned that Dad was willing to co-sign, gift down payment or anything necessary to assist him with making a home purchase and wanted to know how Mom could help.

Here is how Mom, Dad or any other person willing to co-sign impacts the qualifying on a mortgage loan:

Credit

As previously mentioned, all borrowers must qualify independently.

Income

All income, for all borrowers (including co-signers), is added together for qualifying purposes.

Debt

All debt, like income, is added together when calculating qualifying ratios (percentage of income used for house payment and debt).

Assets

All assets, for all borrowers, are added together when determining cash at the time of closing.

All Together?

As long as each borrower qualifies with their credit then the income, debts and assets are all combined when making a decision on the ability to approve the mortgage loan.  In this example, Dad could co-sign with her son and help him qualify.  Each mortgage type has different rules and guidelines related to co-signers.  Make sure to talk with a knowledgeable mortgage lender who can assist you with determining your qualifications.

To slightly modify Thomas Palmer’s famous phrase, “If at first you don’t qualify, try, try a co-signer”.

Lending A Hand

Scott Wynn

The Wynn Team

720 is a good score.  So is 680.  Sometimes even 640 is a good score.  It is all relative.  These scores are scores used by mortgage companies and credit reporting agencies.  Some companies have developed their own credit scoring model that delivers an entirely different type of score put in the form of numbers or even letters.  I used to work for a cell phone carrier and when we ran credit for potential customers we would get responses of A, A-, B, B-, C and so on.  Based on the result we would increase the deposit that was required to obtain a cell phone.  Eventually the deposit was so high that many would opt out of getting a cell phone plan and just use the pre-paid phones that are a lot more popular now than when I was selling cell phones.

Anyway, I got off track there for a moment.  A good score is relative because someone might be interested in what is good enough to get a loan, while another person wants to know what the score needs to be to get the best interest rate.  So here are the answers:

What is Good Enough?

Good enough has been a moving target in the mortgage business because of the multiple companies making restrictions on the credit scores.  There are mortgage investors, mortgage insurance companies, and mortgage broker companies.  All of these companies may have individual restrictions on the credit scores they are willing to lend on and all of them must be followed.  Typically, the minimum credit score allowed for A-Paper mortgage financing is around 620.  There are some exceptions.  For example, I recently assisted a customer who had a 545 credit score and I was able to obtain A-Paper mortgage financing.  This is certainly an exception though.

More than the credit score, the actual items on your credit is the most important when determining what is good enough for mortgage financing.  FHA mortgages do not look at the credit score, but rather look at the actual trade lines on the credit report.  For more details on the requirements for FHA financing check out Mortgage Loan Requirements – FHA.

What Score Gets You the Best Rate?

Just like determining what score is good enough, the score that gets you the best rate is also a moving target.  This target moves more often than the minimum score to get a loan.  Here is an example to give you some idea of what impact your score (all other factors being equal) has on the interest rates:

• 620 = 7.250%
• 640 = 7.000%
• 660 = 6.625%
• 680 = 6.000%
• 700 = 5.625%
• 720 = 5.375%
• 740 = 5.375%
• 760 = 5.375%
• 780 = 5.375%
• 800 = 5.375%
• 850 = 5.375%

As you can see, when the score was above about 720, the rate stayed consistent, up to the highest score I have seen of 850.

It is All Relative

A good credit score is relative upon what you are looking for and I hope this has given you some insight into what a good score is.  If you have any further questions, please email me and I would be happy to reply to your email in the form of a post.

Lending a Hand,

Scott Wynn

Payment Information
When you order your free report here, you will begin your free trial membership in Triple AdvantageSM Credit Monitoring. If you don’t cancel your membership within 9 days of enrollment, the card entered above will be charged $14.95 for each month that you continue your membership. If you are not satisfied, you can cancel at any time to discontinue the membership and stop the monthly billing; however, you will not be eligible for a pro-rated refund of your current month’s paid membership fee.”

That stinks, huh?  All this advertising for a free credit report just to find out you have to sign up for a service to get your report.  There is another method to getting a free credit report though! AnnualCreditReport.com offers a completely free method to run your credit report online.

Annual Credit Report

The site is sponsored by the big 3 credit bureaus, Equifax, Experian and TransUnion.  The reason this site exists, is to allow consumers to understand what is on their credit report.  The Federal Trade Commission, according to the Fair Credit Reporting Act, states:

each of the nationwide consumer reporting companies — Equifax, Experian, and TransUnion — to provide you with a free copy of your credit report, at your request, once every 12 months.

The problem is that most consumers are unaware of this requirement, and therefore go to sites like FreeCreditReport.com to get their report.  For more details on the Fair Credit Reporting Act on the FTC website check out this consumer information page: http://www.ftc.gov/bcp/menus/consumer/credit/rights.shtm.

Other Credit Report Sites

FreeCreditReport.com is a site created by one of the big three credit bureaus – Experian

TrueCredit.com is a very similar site offering a free credit report with monthly monitoring at a cost of $14.95 per month and is created by TransUnion, another one of the big three credit bureaus.

Equifax, the last of the big three, also has a similar offer, but for a little less cost at a monthly charge of $14.95 at their main website, Equifax.com.

Why Would You Pay?

There are a couple of reasons consumers may be interested in paying for the credit monitoring through these sites to gain their credit report.  First, the reports you obtain through AnnualCreditReport.com do not have a credit score, although you can pay a little extra to get one.  All three of the credit bureaus credit reports do provide a score.  Second, identity theft is the fastest rising crime in the United States and people want to be aware of any changes to their credit report.  The credit monitoring provides them that information.

Mortgage Companies Have a Different Score?

It is possible that the consumer score you receive varies from the mortgage score your mortgage lender obtains.  This excerpt comes directly from the Fair Credit Reporting Act and explains there may be a variance:

(f) Disclosure of Credit Scores
(1) In general. Upon the request of a consumer for a credit score, a consumer
reporting agency shall supply to the consumer a statement indicating that the
July 30, 2004 41
information and credit scoring model may be different than the credit score that
may be used by the lender, and a notice which shall include–
(A) the current credit score of the consumer or the most recent credit score of
the consumer that was previously calculated by the credit reporting agency
for a purpose related to the extension of credit;
(B) the range of possible credit scores under the model used;
(C) all of the key factors that adversely affected the credit score of the
consumer in the model used, the total number of which shall not exceed 4,
subject to paragraph (9);
(D) the date on which the credit score was created; and
(E) the name of the person or entity that provided the credit score or credit file
upon which the credit score was created.

Based on this, the credit bureaus provide an educational score to explain the criteria used when calculating a score.  The educational score does not match the mortgage score the mortgage loan officer will get when they pull your credit.  The score that the consumer receives should be used as a general idea of what the score will be from your mortgage lender, but not the actual score being used for qualifications or determining the interest rate.  Typically, from my experience the scores consumers receive are lower compared to the scores I pull through the mortgage credit reports.

If you have any comments or questions please email me.

Lending a Hand,

Scott Wynn