The Importance of Credit History

There has been much written about credit reports and credit scoring. The Internet and money magazines are full of articles about the subject. For most people there is probably too much information out there. Suffice it to say there are few basic principles that people should know, particularly when looking to buy a house or refinance. Consumer rights, with respect to credit reporting, are very well regulated, primarily through the Fair Credit Reporting Act, under the authority of the Federal Trade Commission. The consumer has many tools to assist them in maintaining an accurate credit history. In general, lenders look at overall credit profile, as well as your credit score. 

Everyone should check their credit report periodically. Under federal law consumers have the right to a free annual report. In addition, for a fee, they may obtain reports directly from the reporting agencies at any time. The primary purpose of periodic reviews is to check for errors. Review personal information to ensure it is correct and up-to-date. As a long-time mortgage professional, I can attest to countless situations where the information reported was simply incorrect and an unpleasant surprise to the client. Make sure: balances are correct, payment histories are accurate, paid accounts, collections or judgments show -0- balance. If a negative history cannot be corrected, it is imperative to make sure it is properly reflected as past history. Make sure payoff and settlement dates are correct. Negative credit accounts have a huge effect on credit score, but how recently the negative item occurred, is just as important. The three major credit reporting companies (Trans Union, Equifax and Experian) have simple procedures for disputing incorrect information. If payments have to be made to clear up any delinquent accounts make sure you receive paperwork confirming settlement. A paper-trail is invaluable in the dispute process. 

If you are shopping for a mortgage try to reduce the number of times your credit report is pulled. Excessive inquiries will result in a reduction of credit score.  Changes in legislation have mandated that certain inquiries of similar type, grouped within a short period of time, may be reported as one hit, but the consumer should still limit the number of inquiries to as few as possible. 

While credit history and payment record are a key factor in credit scoring, the amount of debt outstanding can be very important, as well. Sometimes more significant than the total amount of outstanding debt is the relationship of total balances to available credit. For example, a consumer with only two credit cards, total available credit of $2,500 and $2,000 outstanding on those cards, may be rated significantly lower than a consumer who has $10,000 outstanding on eight credit cards with available credit of $25,000. In the first case the consumer is using 80 percent of his available credit while the second consumer is only using 40 percent spread out over numerous cards. This is not meant to encourage consumers to apply for an endless number of credit cards, but merely to be aware of balances and credit limits as they relate to your history and financial strength.  A general rule of thumb is to keep balances below 50 percent of the available limits. Below 30 percent is even better. As for the number of accounts maintained,  many lenders look for a minimum of four open and active credit accounts, with a 12- to 24-month on-time payment history, as part of a strong credit profile. Too many open accounts may be considered a potential credit risk and also increases the risk of identity theft. Four to six accounts is a very manageable number, which should provide most consumers with access to sufficient credit.

Credit scoring models vary somewhat, but the general range is a number between 350 and 850. Managing your current credit and past history is something all consumers should review periodically. Taking steps to improve and maintain you credit score can be invaluable. Many mortgage programs will not even consider a client with a score below a certain required minimum. The minimum required score varies between lenders and programs. It may be 640 for a conforming, Fannie Mae/Freddie Mac loan to as high as 740 for certain jumbo products. What many people don’t realize is the effect credit score can have on rate. A client purchasing a $400,000, borrowing $320,000 (20 percent down) and a credit score of 685 is well within the program guidelines for credit and down-payment. That client may pay a rate a ½ percent higher than a borrower with the same income, same 20 percent down-payment, who has a credit score of 750. That ½ percent increase on 320,000 will cost the first borrower more than $1,125 extra per year. It is also very possible that the first borrower may not have anything terrible in his credit history resulting in the lower 685 score. A careful review 60 to 90 days prior to applying could have revealed that a few simple corrections and modest pay-downs on certain accounts could have significantly raised his score. 

Diligence and modest use of credit are invaluable for anyone considering applying for a mortgage.