One of the most misunderstood areas of mortgage lending is credit scoring. It’s also one of the most pivotal. By understanding the nuances of credit scoring, mortgage loan originators can offer good advice to their clients and help them meet their goals while closing more loans and generating more referrals in the process. It’s not a game, but understanding the rules will max out the chances for your borrowers.
The residential real estate industry is highly complex and constantly changing — from new technologies to evolving regulations to updates on credit-scoring methodology. To keep up and stay successful, it’s critical for mortgage industry professionals to continue learning — even beyond formal continuing-education programs and the certification process through the Nationwide Multistate Licensing System-approved licensing and training.
An area that bears further study for originators is the credit score. One of the top reasons mortgage loans are declined is credit history, according to data from the Home Mortgage Disclosure Act. There are plenty of misconceptions about what makes a borrower’s score rise or fall. Here’s what originators should know.
Many borrowers believe that a “hard inquiry” for a credit account — or when a lender or credit-card company checks a borrower’s credit history — will always negatively impact the score. That’s not the case. Depending on the bureau and number of inquiries already being reported, a single credit-card inquiry may have no impact on the credit score.
Others mistakenly believe collection accounts and public records older than two years have no effect on scores. Collection accounts and public records are considered in the credit score for the entire duration of the time they are reported. Collection accounts can be reported for up to seven years. Although these types of records typically have less impact over time, the collections are considered seriously negative. A six-year-old collection account on a defaulted payment, for example, may be the only reason your borrower has a lower score.
Still, a new collection account being reported doesn’t necessarily hurt a borrower’s score. In most cases, a collection account will hurt the score but, depending on the bureau, scorecard model and other information within the credit report, it may have no impact. In some cases, it can actually help the score depending on what mathematical model is used. A new collection account, for example, may cause a borrower to be scored on a different scorecard. Since all of the information is now being scored differently, this can unexpectedly result in a better score.
Some also believe that paying off accounts that are “in collections” is bad for the score. Although it is true that paying off these types of accounts can negatively impact the score, that isn’t typically the case. It is important to note that these accounts may still be factored into the revolving balance-to-limit ratio — or how much credit is available to a borrower compared to much is being used — and the past-due amounts also are being considered. Therefore, paying off these accounts can often improve the score.
Another commonly held but false belief is that reducing the balance-to-limit ratio to below 50% will always help the score. The boundaries associated with revolving utilization (in relation to score impact) actually vary within each bureau and each scorecard within that bureau.
One more misconception is that a closed revolving account is never considered in the revolving utilization. If there is a balance being reported, the account balance and credit limit will still be considered in the balance-to-limit ratio. This is another example where, from a scoring perspective, paying the balance down to a small amount may be better than paying it off.
What to understand
People often misunderstand why a score can decrease even if there are no changes in the credit report, but the simple passage of time can negatively impact someone’s credit score. For example, a mortgage inquiry doesn’t get factored into the score until it is more than 30 days old, even though it is already listed in the credit report.
Since the age of the accounts being reported impacts various scoring factors, the passage of time can impact a borrower’s score. The age of the accounts can even determine what scorecard is used to calculate the score.
The records are still considered by the score overall, however. A zero balance-to-limit ratio sometimes hurts the score, as it is typically better to have some revolving activity versus none. The exception is when there are too many accounts with a balance.
Clients who pay down an account to a small balance are usually in a better spot than paying it off. A low balance-to-limit ratio will usually help the score. When installment accounts are paid in full, they are automatically closed and are no longer considered in the “balance-to-original loan amount” scoring factor for installment utilization.
A bankruptcy can be reported for up to 10 years. Once removed, it can cause the score to decrease. If it is the only serious negative information factoring into the credit score, this change may cause the borrower to move to another scorecard. As a result, all of the borrower’s information would be scored differently.
The credit-reporting agencies typically view multiple mortgage inquiries made within a short period of time as a single inquiry. People often mistakenly assume that all inquiries made within 30 days will be viewed as a single inquiry, but the time window varies by bureau. Mortgage inquiries within a 45-day period are counted as a single inquiry for Equifax Beacon 5.0 and TransUnion FICO Classic 04. For Experian FICO v2, it is only a 14-day period. This common belief around a “30-day” period stems from the fact that mortgage inquiries are not even considered by the score until they become more than 30 days old. The so-called “shopping window” to make mortgage inquiries, however, is different and varies by bureau.
Mortgage lenders often turn down a loan when a dispute comment appears on a credit report. These comments appear when a borrower challenges a negative account and the credit bureau has initiated an investigation. During the course of the investigation, some information within the account won’t be considered by the score, but a comment will appear indicating that the account has been disputed. Although borrowers may want to get a dispute comment removed, in some cases, removing a dispute can hurt the borrower’s credit score. It is best to use the score-forecasting tools offered by your credit provider to learn what impact can be expected by removing the comment and therefore eliminating unexpected surprises.
Is there a way to tell what caused the score to change between two credit reports? Yes, it is sometimes possible to tell what caused a score to change. Comparing the negative- reason codes that are presented near the credit score within the credit report will sometimes provide insight. These reason codes are presented in the order in which they impact the score. If the reasons (or the order in which they are presented) change between two credit pulls, this can point to the reason for the score change.
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Credit scoring is complex, but keeping up to date on the intricacies is just the beginning. Originators should amp up their knowledge, but also may need to use outside tools to assess specific impacts and find the best plan for every borrower. The goal should be to close every deal for every client, every time.