Understand credit-scoring issues to help your clients with poor or no credit

Thomas R. McKee, president, New West Credit Consultants

As published in Scotsman Guide's Residential Edition, September 2006.

Credit-scoring can be a confusing process for mortgage professionals and their clients. But a greater understanding of credit-scoring issues can help mortgage professionals fund more loans.

Some of the most-common questions that mortgage professionals have about credit deal with helping their clients who have poor or no credit. Consider the following common scenarios.

Question: Should clients pay off old collections, charge-offs, judgments, etc.? If so, how will it affect their credit score?

Answer: When dealing with past derogatory information, mortgage professionals and their clients should consider how paying off such debt affects the clients' credit scores.

This is an unfair aspect to credit-scoring and the algorithm used to calculate this score. Consider this example: A person pays off a collection for $100 that is four years old. First, clients must realize that the older a derogatory item is, the less detrimental it is to their credit. Because of this, loan officers may see clients who are A-credit borrowers but who have a bankruptcy on their credit file.

There are two possible reasons for this: 1. The bankruptcy is probably five to six years old and will soon be removed from the credit report; and 2. The clients have made timely payments and managed their credit wisely since the bankruptcy, and they are rewarded for this positive behavior.

Most derogatory items stay on a credit file for seven years, however. This is based on the date of last activity. When clients make a payment, regardless of how small, it is considered activity. Thus, the person has restarted the seven-year clock, which means the item will stay on for another seven years from the time of the payment.

Question: What if clients don't have any positive credit? How can they best re-establish credit?

Answer: There are many ways to re-establish credit. Some are good, and some simply take too long and are not effective. Here are some common methods:

• Find someone to co-sign for you: This is one of the better ways clients can increase their credit score quickly and effectively. It requires that they have a close friend or relative who trusts them and who has good credit. Clients must still meet their financial obligations and not default because the creditor will go after both parties for full payment. This could potentially hurt both of their credit ratings.
• Department-store credit cards: It is usually easy to qualify for this type of credit because the guidelines are typically less strict than for other types of credit. Keep in mind, however, that these credit cards are also rated lower than other types of credit. Plus, it takes a long time to develop a history for the account. It is thus a time-consuming approach to increasing your clients' credit history while improving their score.
• Secured credit cards: This method is costly and time-consuming. Keep in mind that all types of credit are rated differently, and this is one of the lowest-rated types of credit. Plus, the time it takes to develop a history for this type of account makes for a long process of improving your clients' credit.

Remember, though, that clients must make certain that the credit company regularly reports to the three major credit-reporting agencies -- Experian, Equifax and TransUnion.

Also, clients should keep the balances on these accounts to a minimum. A high debt-to-credit ratio is a large factor in the algorithm used to calculate credit scores -- the higher the ratio, the more negatively it will affect the score.

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By understanding how to help clients improve their credit scores, mortgage professionals can gain trust, build their businesses and fund more loans.

Thomas R. McKee is president of New West Credit Consultants, a firm that works with mortgage professionals to help improve their clients' credit scores to obtain more-favorable rates and terms on their home loans. He can be reached at (605) 323-1316 or by e-mail at tom@newwestcc.com. Visit New West Credit's Web site, www.newwestcc.com. Need advice on credit scenarios or questions? E-mail them to tom@newwestcc.com.