The EMG Blog

Credit Scoring and How It Works

Credit scoring is a statistical method that lenders use to quickly and objectively assess the credit risk of a loan applicant. The score is a number that rates the likelihood you will pay back a loan. Scores range from 350 (high risk) to 850 (low risk). There are a few types of credit scores; the most widely used are FICO scores, which were developed by Fair Isaac & Company, Inc. for each of the credit reporting agencies.

Credit scores only consider the information contained in your credit profile. They do not consider your income, savings, down payment amount, or demographic factors like gender, race, nationality, or marital status. Past delinquencies, derogatory payment behavior, current debt level, length of credit history, types of credit, and number of inquiries are all considered in credit scores. Your score considers both positive and negative information in your credit report. Late payments will lower your score, but establishing or reestablishing a good track record of making payments on time will raise your score. Different portions of your credit file are given different weights.
They are:

  • 35% – Previous credit performance (specific to your payment history)
  • 30% – Current level of indebtedness (current balance compared to high credit)
  • 15% – Time credit has been in use (opening date)
  • 15% – Types of credit available (installment loans, revolving and debit accounts)
  • 5% – Pursuit of new credit (number of inquiries)

The most important factor for a good credit score is paying your bills on time. Even if the debt you owe is a small amount, it is crucial that you make payments on time. In addition, you may want to keep balances low on credit cards and other “revolving credit;” apply for and open new credit accounts only as needed; and pay off debt rather than moving it around. Also don’t close unused cards as a short term strategy to raise your score. Owing the same amount but having fewer open accounts may lower your score.

Recent changes minimize the negative effects that rate shopping can have on a mortgage applicant. If there is a consumer originated inquiry within the past 365 days from mortgage or auto related industries, these inquiries are ignored for scoring purposes for the first 30 calendar days; then, multiple inquiries within the next 14 days are counted as one. Each inquiry will still appear on the credit report.

Every score is accompanied by a maximum of four reason codes. Reason codes identify the most significant reason that you did not score higher. The reason codes can help a lender describe the reasons for higher than expected rates or loan denial. Scores are not part of the credit profile and are not covered by the Fair Credit Reporting Act.

Your credit report must contain at least one account which has been open for six months or greater, and at least one account that has been updated in the past six months for you to get a credit score. This ensures that there is enough information in your report to generate an accurate score. If you do not meet the minimum criteria for getting a score, you may need to establish a credit history prior to applying for a mortgage.

*Note: American Pacific Mortgage Corporation is not a credit repair company; this information is for information purposes only. We are not licensed credit repair specialists or counselors.

*The views, articles, postings and other information listed on this website are personal and do not necessarily represent the opinion or the position of American Pacific Mortgage Corporation.

Your Credit Report

Your credit report provides information to current and prospective creditors to help you make purchases, secure loans, pay for college educations, and manage your personal finances. Credit reporting makes it possible for stores to accept your checks, banks to offer credit and debit cards, businesses to market products, and corporations to better manage their operations to benefit the world’s economy.

Your credit report is only compiled when you or a lender makes an inquiry. Information supplied by lenders, you, and court records is gathered from the credit reporting agency’s file and presented in report format for the requester.

Credit grantors send updates to each of the credit reporting agencies, usually once a month. These updates include information about how their customers use and pay their accounts.

Under the Fair Credit Reporting Act, you may be entitled to receive a free copy of your personal credit report if you have been declined credit, housing, or employment in the last 60 days. To request your free copy, ask your mortgage company or contact one of the credit reporting agencies directly.

*Note: American Pacific Mortgage Corporation is not a credit repair company; this information is for information purposes only. We are not licensed credit repair specialists or counselors.

*The views, articles, postings and other information listed on this website are personal and do not necessarily represent the opinion or the position of American Pacific Mortgage Corporation.

How to Improve Your Credit

If you have had credit problems, be prepared to discuss them honestly with a mortgage professional. Responsible mortgage professionals know there can be legitimate reasons for credit problems, such as unemployment, illness, or other financial difficulties. If you had a problem that’s been corrected and your payments have been on time for a year or more, your credit may be considered satisfactory.

If you are currently in excess debt, there are four ways to control it:

  1. If your credit is not in terrible shape, you can reduce your other expenses, even if it means making hard choices or changing your lifestyle to fit your income. Consider selling a second car, taking equity out of your home, applying for a non secured signature loan, obtaining a loan from a relative, selling your home and paying off your debts with the proceeds and then renting, cashing out your 401K/retirement benefits, or selling family heirlooms, jewelry, etc.
  2. If your credit is already damaged or one of the above isn’t an option, go through Consumer Credit Counseling Services (CCCS). Check your yellow pages for the local number. CCCS may be able to help you pay off your debts as if you were in a Chapter 13 bankruptcy, but you don’t actually file for bankruptcy.
  3. If CCCS won’t take you, you may want to consider bankruptcy. Claiming Chapter 13 bankruptcy takes longer than a Chapter 7, but your credit will end up in a little better standing. Chapter 13 bankruptcy gives you up to 5 years to pay off your debts. The disadvantage is that you’re in bankruptcy for up to 5 years plus your credit report shows your bankruptcy for 7 more years after you have finished paying off your debts.
  4. If you are so far in debt that you can never repay it, then one solution may be a Chapter 7 bankruptcy. A Chapter 7 bankruptcy is the least desirable from a credit standpoint, but you are typically out of bankruptcy in 6 months and you don’t have to repay any debt. The disadvantage is that this shows on your credit report for 10 years from the date of filing your bankruptcy. Creditors are starting to tighten their credit requirements, and you may have a tough time getting future financing.

If your debts are under control now, but want to improve your bad credit history, the most important factor is to make your monthly payments on time. Use pre-addressed envelopes enclosed with your statements to mail your payments and call the company if you don’t receive your usual statement. Also, send your payment as early as possible if you carry a balance. Most companies calculate interest on a daily basis, so the sooner they receive your payment, the less interest you’ll pay.

Don’t procrastinate. It’s the day your payment is received that counts, not the postmark date. Give the post office sufficient time (five business days is a good guideline) to deliver your mail. Late payments may mean late fees, higher interest, and/or a negative mark on your credit report.

Never send cash. Open a checking account if you don’t have one, or spring for a money order and keep your receipt. Finally do not forget to tell your creditors your new address when you move.

If you are worried about making payments, make a list of your debts and when the payments are due. Contact your lenders immediately if you think you will have trouble meeting the monthly payments to arrange a payment schedule.

Taking money from your retirement account or tapping the cash value of your life insurance policy to pay bills or living expenses may have serious implications you haven’t considered, so try to get advice from an expert before you take any major financial actions.

Credit cards can be invaluable in a crisis, since they allow you to charge items and pay them off over time. But they can also be dangerous if you aren’t careful and charge more than you can afford. If you do use credit cards, choose those with the lowest interest rates and pay them back as soon as you can to cut your costs.

*Note: American Pacific Mortgage Corporation is not a credit repair company; this information is for information purposes only. We are not licensed credit repair specialists or counselors.

*Note: American Pacific Mortgage Corporation is not a credit repair company; this information is for information purposes only. We are not licensed credit repair specialists or counselors.

*The views, articles, postings and other information listed on this website are personal and do not necessarily represent the opinion or the position of American Pacific Mortgage Corporation.

Get Your Hands on Some Cash

Another way to make a refinance work for you is to refinance for more than the balance remaining on your old mortgage — in effect, tapping your home equity, or “cashing out,” in mortgage speak. Thanks to favorable rates, you may be able to do so without boosting your monthly outlay. For example, at 8.5%, the payment on a $200,000, 30-year fixed rate mortgage is $1,538. But at 7.5%, that same payment lets you borrow nearly $20,000 more.

A good use for the extra cash is to pay off any higher rate loans you may have. Let’s say that you are carrying a $15,000 car loan at 10% and making minimum payments on a $10,000 credit card balance at 17%. Your monthly payments on those debts would total $680. Then assume you refinanced your mortgage, taking out an additional $25,000 to pay off your car and credit card loans. Result: At 7.5%, your additional monthly mortgage payment would total only $175, so you would come out $505 ahead ($680-$175=$505).

Of course, all the extra cash needn’t go for paying off debts. When the Menards swapped their ARM for a fixed rate last December, they also increased their mortgage load by $34,000, from $106,000 to $140,000. They used $3,000 of the proceeds to pay their refinancing costs and another $17,000 to pay off a 10% home equity loan, which had been costing them $250 a month. Then they spent the remaining $14,000 to build a garage for Roger’s antique car collection — and they did all this for just another $19 a month.

Please visit our Disclosures page for more details for all loan types.

*The views, articles, postings and other information listed on this website are personal and do not necessarily represent the opinion or the position of American Pacific Mortgage Corporation.

Build Home Equity Faster

Many borrowers use a refinance to shorten the term of the mortgage. And brace yourself, even at low rates, a shorter term means a higher monthly payment. The benefit is that you’ll build up equity faster and pay far less in total interest over the life of the loan.

Consider Jim Neill, 48, a real estate broker and his wife Merrilyn, 55, a psychotherapist. Recently, the couple took out a 15-year fixed rate loan at 6.75% to replace an 8.13% ARM with a 30-year term. Their monthly payment jumped by $200, but now they will own their own home outright by the time they retire. In addition, the total interest on the 15-year loan will come to $95,447, vs. $222,234 on the remaining life of the ARM — and that assumes their adjustable rate would have held steady at its current 8.13%. “This is forced savings,” says Jim. “When we retire, we can scale down and take equity out of the house.”

If you can’t afford the payments on a 15-year mortgage, your next means of building equity is to refinance for less than 30 years. To do so, ask your mortgage company to customize your new loan’s term to match the years that are left on your old loan — if you are five years into a 30-year mortgage, for example, ask for a 25-year loan.

Please visit our Disclosures page for more details for all loan types.

*The views, articles, postings and other information listed on this website are personal and do not necessarily represent the opinion or the position of American Pacific Mortgage Corporation.

Refinance Considerations

When you’re making your decision, there are several things to keep in mind.

If your current interest rate is significantly higher than today’s lowest rates, you may be able to roll your loan costs into the loan and still get a lower rate than you have today, thereby reducing your interest payments and saving money immediately.

Second, if you are planning to stay in your home for at least three to five years, it may make sense to pay “points” (a point equals 1% of the loan amount) and closing costs to get the lowest available rate.

And third, you can avoid laying out cash and still get a low rate by adding the points and closing costs to your new mortgage. Does that mean shouldering a lot of extra debt? Not necessarily. If you’ve had your current mortgage for at least three years, you’ve probably reduced your balance by several thousand dollars. So you may be able to tack your closing costs onto your new loan and still end up with a mortgage that’s smaller than your original one — plus, of course, a lower rate and lower monthly payment.

*The views, articles, postings and other information listed on this website are personal and do not necessarily represent the opinion or the position of American Pacific Mortgage Corporation.

Mortgage Refinance Costs

When you refinance your mortgage, you usually pay off your original mortgage and sign a new loan. With a new loan, you again pay most of the same costs you paid to get your original mortgage. These can include settlement costs, discount points, and other fees. You also may be charged a penalty for paying off your original loan early, although some states prohibit this. The total expense for refinancing a mortgage depends on the interest rate, number of points, and other costs required obtaining a loan.

To obtain the lowest rate offered, most mortgage companies will charge several points, and the total cost can run between three and six percent of the total amount you borrow. So, for example, on a $100,000 mortgage, the company might charge you between $3,000 and $6,000. However, some companies may offer zero points at a higher interest rate, which may significantly reduce your initial costs, although your payments may be somewhat higher.

*The views, articles, postings and other information listed on this website are personal and do not necessarily represent the opinion or the position of American Pacific Mortgage Corporation.

Deciding to Refinance

Traditionally, the decision on whether or not to refinance has meant balancing the savings of a lower monthly payment against the costs of refinancing. But in recent years, companies have introduced “no cost” and low cost refinancing packages that minimize or completely eliminate the out-of-pocket expenses of refinancing. (These refinancing packages compensate with a higher interest rate, or by including some of the costs in the amount that is financed.)

With traditional refinancing, the most often cited rule of thumb is that the interest rate for your new mortgage must be about 2 percentage points below the rate of your current mortgage for refinancing to make sense. However, with the newer low and no cost refinancing programs, it can be worth your while to refinance to obtain a smaller reduction in interest rates.

How long you expect to stay in your home is also a factor to consider. If you’ll be moving in a few years, the month to month savings may never add up to the costs that are involved in a refinancing.

Please visit our Disclosures page for more details for all loan types.

*The views, articles, postings and other information listed on this website are personal and do not necessarily represent the opinion or the position of American Pacific Mortgage Corporation.

Appraisal Needed To Obtain Loan

This post is a part of the “Ultimate Guide to Home Financing” blog series.

Usually, individuals applying for a loan are only interested in obtaining the loan and unfortunately are not worried about the prudence of buying the property at the agreed price. In fact, many purchasers will try to encourage appraisers to increase the appraised value so that they can purchase the home regardless of its value.

The majority of real estate appraisals are requested by mortgage companies to validate the property’s purchase price for loan purposes. Except for periods of very low interest rates when everyone is refinancing, most loans are for the purchase of real estate and ordered after a sale price is negotiated. Purchasers mistakenly assume that mortgage companies are looking after their interests in the purchase transaction.

The law states that if the mortgage company orders the appraisal, the appraiser is responsible only to the mortgage company. We expect mortgage companies to be prudent and they should be, but being prudent is protecting their interest, not necessarily the purchaser’s. The mortgage company’s position is:

  • It has two sources of repayment: the purchaser’s income and the property.
  • The responsibility to repay the loan is not based upon the property’s value, so the purchaser is obligated to pay the note even if the property value declines to zero.
  • The loan may be insured or guaranteed by a government agency.
  • The government does not promise to pay the purchaser’s debt if the property value is wrong.
  • If the loan is greater than 80% of the value, a portion of the loan may be insured by a private mortgage insurer.
  • There is no decrease in risk for the purchaser regardless of the loan to value ratio. The investment by the purchaser is the same; a mixture of personal cash and a loan that must be repaid.

*The views, articles, postings and other information listed on this website are personal and do not necessarily represent the opinion or the position of American Pacific Mortgage Corporation.

Appraisal Methods

This post is a part of the “Ultimate Guide to Home Financing” blog series.

 

An appraisal is an opinion of value or the act or process of estimating value. This opinion or estimate is derived by using three common approaches, all derived from the market.

  1. The cost approach to determining value is to estimate what it would cost to replace or reproduce the improvements as of the date of the appraisal, less the physical deterioration, the functional obsolescence and the economic obsolescence. The remainder is added to the land value.
  2. The comparison approach to determining value makes use of other “benchmark” properties of similar size, quality and location that have been recently sold. A comparison is made to the subject property.
  3. The income approach to determining value is of primary importance in ascertaining the value of income producing properties and has little weight in residential properties. This approach provides an objective estimate of what a prudent investor would pay based upon the net income the property produces.

Then, after thorough analysis of all general and specific data gathered from the market, a final estimate or opinion of value is correlated.

*The views, articles, postings and other information listed on this website are personal and do not necessarily represent the opinion or the position of American Pacific Mortgage Corporation.