Chapter 4: Credit Reports and Loan Qualification

Reviewing your credit report regularly is a good idea, but it is particularly important before seeking a mortgage loan. Check your reports at least 60 days before you plan to apply for financing, as it can take some time to resolve issues that may arise.

Your Credit Report
Credit bureaus gather most of the information about you from your creditors, but also search court records for lawsuits, judgments, and bankruptcy filings. The credit and public record data is compiled with your identification information. The mortgage lender will use the report to assess your credit history for loan qualification.

Your credit report should reflect only accurate information. Obtain your reports from all three credit bureaus – TransUnion, Equifax, and Experian – and read them carefully for errors. You may receive a free copy of your credit reports once a year through Annual Credit Report Request Service, or you may order them directly from the credit bureaus for a fee.

Your Credit Score
A credit score is one of the most important tools lenders use to evaluate your mortgage application. Scores are determined only by the information on your credit report that can predict future credit performance. Therefore, income, employment history, race, religion, national origin, gender, marital status, and age are not factors.

Fair, Isaac and Company developed the most commonly used score, called a FICO score. These scores range from 300 to 850, with a higher number being indicative of less risk. Generally, the higher your score, the easier it will be for you to get a loan with a low rate of interest. While there is no perfect credit score, most mortgage lenders look for a score of at least 620 when considering you for a good loan.

Credit scores constantly change with credit activity, and recent events matter more than what happened long ago.

Though there are many categories of credit information used to determine your FICO score, some are much more significant in their impact than others:

• Payment history = 35 percent. The more consistent your payment history, the better your score will be.
  
  
• Amounts owed = 30 percent. The amount of outstanding debt you have has a strong impact on your credit score. Carrying high balances, especially if the balances are close to the credit limit, can lower your score.
  
  
• Length of credit history = 15 percent. Accounts that you’ve had for more than two years will have a more positive impact on your score than newer accounts.
  
  
• New credit = 10 percent. The type, number, and proportion of recently opened accounts matter, as do inquiries. All mortgage and auto loan inquiries within a fourteen-day period are considered just one for scoring purposes, and any mortgage or auto loan inquiries made within 30 days of an application are disregarded. Working toward reestablishing a positive credit history after past payment problems counts in this section as well.
  
  
• Types of Credit Used = 10 Percent. Having and using a variety of credit instruments (such as credit cards, retail accounts, installment loans, a mortgage, and consumer finance accounts) responsibly is favorable to your score.

Improve Your Credit Report
If your standing and scores aren’t where they should be, you can make significant improvements by taking action:

• Correct errors – Using the “request for investigation” form provided with the report (or in a letter if you don’t have the form), indicate which information is incorrect, and explain what the true information is and enclose supporting documents. If you received the report online, you may use the dispute process on the bureau’s website. The credit bureau must investigate your claim, usually within 30 days. If the investigation results in no change and you believe the information is still inaccurate, contact the creditor directly and request documentation of the debt. If they can’t provide it, let the credit bureau know – only verifiable debts can be reported.
  
  
• Use credit responsibly. While time heals credit wounds, you can kick-start the improvement process:
  • Make timely payments from this point forward.
  • Repay any collection accounts you may have.
  • Have the right number of open credit accounts. In general, two to four active accounts are enough to show capacity but not so much as to appear risky.
  • Keep older credit accounts active. The farther back your positive credit history goes, the better your score.
  • Maintain balances of no more than 60 percent of the credit limit.
  • Transfer balances only when the financial benefit outweighs the potential credit damage.
  • Frequent balance transfers can harm your credit score – the increased activity can make you appear to be a credit risk, and having too many active accounts can be derogatory.
  • Avoid excess credit applications. Only apply for accounts you really need.