A Borrower’s Knowledge of Credit Scoring
Part of the job of an MLO is to educate potential borrowers about mortgages. Many borrowers are new to mortgage financing and lack knowledge about what impacts their ability to obtain a mortgage. A key area where a lack of knowledge can greatly impact their ability to obtain a mortgage is credit scores. Even though the credit scores have been around for decades, a lack of understanding can negatively impact a person’s ability to borrow. This blog is a short explanation of how credit scores are determined and information you can share with your prospective borrowers.
What is a Credit Score?
A credit score, often referred to as a FICO score, is a numerical representation of a person's creditworthiness. Lenders use this score to assess the likelihood that a borrower will repay their mortgage. The score is based on data found in your client’s credit report, which reflects their payment history and the management of past debts. Credit scores are generated by three main credit bureaus—Experian, Equifax, and TransUnion—and while there may be small differences between these scores, they are generally similar.
Key Factors That Affect Credit Scores
It’s important for your clients to understand how their credit score is calculated. Several factors contribute to their score, each weighted differently:
Payment History (35%)
The most significant factor, this reflects whether your clients have paid their bills on time. Late payments, defaults, and bankruptcies can severely damage their score.
Credit Utilization (30%)
This measures the ratio of credit card balances to credit limits. Clients should aim to keep their utilization rate below 30% to maintain a healthy credit score.
Length of Credit History (15%)
The longer a client’s credit history, the better. Lenders favor borrowers with well-established credit histories, typically at least six months of consistent credit use.
Credit Mix (10%)
A diverse mix of credit types (such as credit cards, auto loans, and student loans) can positively impact a credit score. It shows the client’s ability to manage different forms of debt responsibly.
New Credit Accounts (10%)
While opening new credit accounts can increase a client’s available credit, it can also lower their average credit age, which could temporarily hurt their score. It's essential to weigh the benefits and drawbacks.
Understanding Credit Score Ranges
Here's a breakdown of what different credit score ranges mean for your clients when applying for a mortgage:
Excellent (750-850): Clients with scores in this range will generally qualify for the best mortgage rates and terms.
Good (700-749): A solid score that can still offer favorable terms, though slightly higher rates than those with excellent credit.
Fair (650-699): Clients with fair credit may face higher interest rates but can still qualify for a mortgage.
Poor (below 650): Clients in this range may struggle to qualify for a mortgage or may receive less favorable terms, such as higher interest rates.
Different loan types—such as FHA, VA, or conventional loans—have varying credit score requirements. By working with your clients, you can determine the best loan options based on their credit score.
How Clients Can Monitor Their Credit
Encourage your clients to check their credit reports regularly, especially before applying for a mortgage. Each of the three credit bureaus offers one free credit report annually through AnnualCreditReport.com. A good approach is to pull a report from a different bureau every four months, giving clients an ongoing look at their credit health throughout the year.
In addition, clients can keep an eye on their FICO score through credit card providers or other services that offer free credit score monitoring.
Tips to Help Clients Improve Their Credit Score
If your clients need to improve their credit score, offer these actionable tips:
Pay bills on time: Late payments can have a significant negative impact on a credit score.
Reduce credit card balances: Advise clients to aim for a credit utilization rate below 30% of their credit limit.
Avoid applying for new credit unnecessarily: Opening new accounts can lower their average credit age, which could hurt their score.
Check credit reports for errors: Mistakes can lower a client’s score unnecessarily. Clients should dispute any inaccuracies they find on their reports.
Keep old accounts open: Closing an old account can shorten a client’s credit history and lower their score.
Why Credit Scores Matter for Mortgage Approval
Clients often don’t realize how much their credit score affects the interest rate and terms they’ll receive for their mortgage. Higher scores not only increase the likelihood of loan approval but also secure lower interest rates, potentially saving them thousands of dollars over the life of the loan.
Helping Clients on Their Mortgage Journey
As their mortgage professional, your clients will rely on you to help them understand how their credit score impacts their home-buying journey. By providing this information, you can guide them towards making informed decisions that improve their chances of securing a loan with the best possible terms.
Encourage your clients to start reviewing and, if necessary, improving their credit scores as early as possible. Together, you can work on identifying the best loan options that fit their financial situation.
By providing this resource, you'll help your clients take control of their credit health and position themselves for success when it comes to securing a mortgage.