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Historically, mortgage interest rates have
varied by loan-to-value and by term only. On "A" borrower mortgages, variation
in credit risks were not generally taken into consideration. Any variation in
interest rates was primarily due to the additional charge for mortgage
insurance on home loans with loan-to-values greater than 80 percent, or higher
rates de to the length of amortization (30 years vs. 15 years). The exception
to this trend is sub-prime loans. Sub-prime lenders are lenders who specialize
in providing loans to borrowers who cannot qualify for traditional financing
due to credit impairment or difficult to verify income. These lenders have used
"risk-based" pricing for years. The greater the risk, the higher the interest
rate. A leading credit indicator used by lenders to determine risk based
pricing is the FICO (Fair Isaac Company) Score. Mortgage lenders use FICO
Scoring to speed up the loan application process by simplifying credit review.
Recently - in the last two years - Fannie Mae and Freddie Mac have also
incorporated FICO Scoring into their credit documentation requirements on prime
mortgage loans.
FICO Scoring is a formula for credit risk
assessment that is believed to be highly predictive of future payment
risk.
The borrower's score is derived weighing credit information at a
snapshot in time and assessing "points" for each piece of information. The
information is taken from a credit bureau file and scores are based on credit
information only. By law, an applicant's credit worthiness cannot be judged on
race, religion, marital status, gender or nationality. According to Fair Isaac,
the information is, therefore, objective, consistent and does not discriminate.
FICO Scores can fluctuate, however. Depending on the credit repository the
information is taken from and the geographical location of the borrower, there
may be more or less information available, which leads to variation in scoring.
Calculation and Higher Risk
Characteristics
The borrower's score is calculated based on assigned
numerical values for certain credit characteristics. The higher the overall
score the less risk there is for the lender. Bankruptcy; Non-bankruptcy
derogatory public records; Charge-offs or loan defaults; Repossession; Serious
delinquency.
Additional
Characteristics that determine credit are:
- Number and age of trade lines
- Presence of derogatory trade line information
- Current level of indebtedness
- Types of credit available (revolving vs.
installment)
- Amount of time credit has been in use
- Credit inquiries
Weight
Credit usage is the key factor.
Each characteristic is weighted according to its "predictive power." Those
factors with the highest weights are:
- Collections
- Judgments
- Bankruptcies
- Late payments
- Current balances
- Too few or too many revolving accounts
- Finance company accounts
- Number of accounts opened in the past 12 months
- Collections and number of credit inquiries made
FICO Scoring looks at credit patterns over a
period of time. In other words, one late payment will not ruin your credit
score. However, a history of late payments and high credit balances will have a
serious effect on an individual's score.
Errors
made the spouse responsible
for the outstanding debt. If the buyer has a bankruptcy that was discharged,
there may be outstanding charge-offs or unpaid collections on the report that
in fact were discharged through the bankruptcy. Buyers should check their
credit reports at least once per year.
If the buyer feels there are errors contained
in their credit report, they should contact the credit bureau. According to the
Fair Credit Reporting Act, borrowers may fill out credit dispute forms and file
them with the credit bureau for investigation. They may do so by contacting the
appropriate credit repository.
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