As the deadline draws near to take final advantage of one-time, federal home buying tax credit, many consumers who yearn to make the transition from renters to homeowners will seriously consider whether the time is right to “make that move.” With a large inventory of homes in most markets, coupled with comparatively low home prices and mortgage interest rates, many may find the opportunity for an $8,000 tax credit tempting.
While those factors hold true for most of the nation, another key factor will figure prominently into whether a mortgage lender will finance a home purchase: Credit scores. Due to the still-evolving financial crisis, many lenders are only writing loans for consumers with ‘good’ credit scores. So for those intending to file a mortgage application, it would be wise to understand what is taken into account in reaching credit scores and how individual scores rank on the competitive market.
Fair Isaac Corporation (FICO) scores range from 300-850 and measure how well consumer credit has historically been handled. In general, higher scores lead to better credit terms. In the case of mortgage lending, the direct benefit could be a lower interest rate over the life of the loan. On a 30-year, $300,000 mortgage, a difference of 100 points could mean either saving or paying $40,000 in interest over the life of the loan. Consumers with scores of 700 or most often qualify for lower mortgage rates.
As a result, it is important for consumers to be aware as to how scores are calculated. Several factors comprise the scoring process and include payment history, debt amounts, length of credit history, new credit and credit mix. However two of these measures, payment history and debt, account for 65 percent of a FICO score.
Payment history is weighed the heaviest and accounts for 35 percent of the final FICO score. Long-term consumer history on payments for credit cards, installment loans such as auto and student loans are considered in this specific measurement. The larger the loan, the more important it is to have a history that demonstrates regular and timely payments.
The importance of payment history cannot be overstated. Among the largest banks, 90 percent use FICO scores to make decisions. For example, if a consumer had a FICO score of 680 and then missed a monthly debt payment, that one failure could lower their score by 60-80 points.
Consumers’ current total debt comprises another 30 percent of FICO scores. The difference between credit limits and how much is obligated determines how well this portion of the score is reached. Consumers who have utilized all of their credit limits will be considered more risky than those who maintain low balances. Utilizing only 30 percent of a given credit limit is usually considered the best way to score well on debt. The length of consider credit history accounts for another 15 percent of credit scores. This factor typically works against young consumers. Instead of having bad credit history, many young people simply have none. The remedy to that lack is to create a history of responsibly handling a manageable but small credit accounts or installment payments. By creating a short credit history of this kind, young consumers are more likely to gain the ability to purchase an automobile without a co-signer. In turn, if the installment loan shows a pattern of regular payments, the likelihood of being able to secure financing to purchase a home will improve.
The last two factors, new credit and credit mix respectively represent 10 percent of the total score. Having too many open lines of credit can hurt more than having none. For example if a retail clerk offers a discount on a purchase for opening a new credit account, thoughtfully consider how much credit is already been obligated. The 10 or 15 percent reduction on a purchase may not be worth opening a new account.
The current tightening of credit has also led to a number of misleading offers for free credit score reports. In many instances, these ‘free’ services often wind up as long-term, monthly subscription programs and penalty fees if consumers cancel before conclusion of a trial period.
As of April 2, a new Federal Trade Commission (FTC) rule requires such firms to fully disclose their real terms. A better approach would be to visit the government-mandated site, www.annualcreditreport.com where each year consumers can receive a free credit report.
For communities of color, access to credit has been historically problematic — especially in the area of mortgage lending. So if the 2010 first-time homeowner tax credit is the motivator to purchase your own American dream, assess your financial forecast before applying for a mortgage loan. Every consumer needs to know their own credit score.
This article was originally published in the April 26, 2010 print edition of The Louisiana Weekly newspaper
|
