When you apply for a mortgage loan, you expect your lender to pull a credit report and look at whether you’ve made your payments on time. What you may not expect is that they seem to be more interested in your “FICO” score.
FICO actually stands for Fair Isaac and Company, which is the company used by the Experian (formerly TRW) credit bureau to calculate credit scores. Trans-Union and Equifax are two other credit bureaus who also provide credit scores.
Each time your credit report is pulled, it is run through a computer program with a built-in scorecard. Points are awarded or deducted based on certain items such as how long you have had credit cards, whether you make your payments on time, if your credit balances are near maximum, and assorted other variables. When the credit report prints in your lender’s office, the total score is displayed. Your score can be anywhere between the high 300’s and the low 800’s.
Back prior to the market crash, credit scoring had little to do with mortgage lending . When reviewing the credit worthiness of a borrower, an underwriter would make a subjective decision based on past payment history. Then things changed. Lenders wanted to determine if there was any relationship between these credit scores and whether borrowers made their payments on time, so they did a study. The study showed that borrowers with scores above 680 almost always made their payments on time. Borrowers with scores below 600 seemed fairly certain to develop problems.
Almost half of those borrowers with FICO scores below 550 became ninety days delinquent at least once during their mortgage. On the other hand, only two out of every 10,000 borrowers with FICO scores above eight hundred became delinquent.
As a result, credit scoring became a more important factor in approving mortgage loans. Credit scores also made it easier to develop artificial intelligence computer programs that could make a “yes” decision for loans that should obviously be approved. Nowadays, a computer and not a person may have actually approved your mortgage. In short, lower credit scores require a more thorough review than higher scores. Often, mortgage lenders will not even consider a score below 600.
Sounds confusing, doesn’t it?
The credit score is actually calculated using a “scorecard” where you receive points for certain things. Creditors and lenders who view your credit report do not get to see the scorecard, so they do not know exactly how your score was calculated. They just see the final scores.
Basic guidelines on how to view the FICO scores vary a little from lender to lender. Usually, a score above 680 will require a very basic review of the entire loan package Scores between 640 and 680 require more thorough underwriting. Once a score gets below 640, an underwriter will look at a loan application with a more cautious approach. Many lenders will not even consider a loan with a FICO score below 600, some as high as 620.
FICO Scores and Interest Rates
Credit scores can affect more than whether your loan gets approved or not. They can also affect how much you pay for your loan, too. Some lenders establish a “base price” and will reduce the points on a loan if the credit score is above a certain level. For example, one major national lender reduces the cost of a loan by a quarter point if the FICO score is greater than 725. If it is between 700 and 724, they will reduce the cost by one-eighth of a point. A point is equal to one percent of the loan amount. There are other lenders who do it in reverse. They establish their base price, but instead of reducing the cost for good FICO scores, they “add on” costs for lower FICO scores. The results from either method would work out to be approximately the same interest rate. It is just that the second way “looks” better when you are quoting interest rates on a rate sheet or in an advertisement.