With advances in technology, credit scores have taken on a determining factor in the mortgage process. This guide is a general guide to help you assess the terms you may expect from a lender based on your credit. Keep in mind each lender has their own methods for evaluation.
The following are the main criteria for determining your credit score:
Types of Credit
Mortgage Credit comes from your payment history on your existing, or previous mortgage. Lenders can determine a borrower's inclination towards a mortgage by viewing the payment history of a previous mortgage. The payment history on a mortgage is extremely important in determining your credit grate.
Consumer Credit refers to installment and revolving credit.
Installment credit refers to long term credit with structured payment plans. ie. Car Loans or Student Loans.
Revolving credit refers to department store and bank credit cards.
Generally any payment that is received 30 days late is reflected as a late payment on your credit report.
Public Records relates to previous bankruptcies, collections, foreclosures and judgents. In order to get a mortgage the A borrower cannot have any bankruptcy within the past 2-10 years. The D borrower could be in bankruptcy or foreclosure.
As the credit problems become more serious, your credit score declines, the more the mortgage lenders increase your fees and interest rates.
Lenders will also review the ability for borrower to repay the mortgage by calculating their debt ratio. They do this by dividing the borrower's total monthly debt by the total monthly income. For example, if the total obligations of the borrower is $1,400 ($1,000 for housing expenses and $400 for other credit obligations), the debt ratio would be 35% (1,400/$4,000 = 35%).
The lower debt ratio means a higher grade, and a higher debt ratio means a lower credit grade.
The Loan to Value Ratio, or LTV, is the ratio of the loan amount to the appraised value of the property (or the sales price, whichever is less). If you get a loan of $100,000 on a property valued at $200,000, the LTV is 50%. The better your credit grade, the higher your LTV can be. ie. An A borrower can get a loan with an LTV of 100%, whereas the D borrower would only be able to borrow with an LTV average 65% to 75%.
With the advent of new technology, lenders frequently use credit scores (FICO scores) to determine someone's credit risk. The higher the credit score, the better the risk.
Credit bureaus have their own system for computing a credit score based on their own data; however, the numerical score from one bureau is equivalent to the numerical score at another. The calculations may differ, but a 700 at one company is comprable to a 700 at another. With a range of 375-900, a score of 650+ is indicative of a good credit history. Average FICO falls between 625-650.
Note: Each lender weighs the importance of a credit score differently.
The Interest Rate
Lenders use the four main factors to determine the interest rate: Public Records, Debt Ratio, Loan to Value Ratio, and your Credit Score. If all four factors are great, the loan is an "A" grade, and qualifies for the best rates. If one factor is not excellent, the loan is downgraded to an "A-", "B", "C", or "D" paper. D papers are "hard money loans" which are based on equity in your home instead of your credit. Because a loan for a B, C, or D paper loan requires a higher risk due to the increased likelihood of the borrower defaulting, the lender compensates for the higher risk by increasing the interest rate.
Here is an example of increased interest rates
A- might be +1%-1.75% higher than A papers
B might be +.25%-.75% higher than A- papers
C might be +.75%-1.5% higher than B papers
D might be +1%-1.75% higher than C papers.
Interest rates quoted for any papers can vary quite a bit from lender to lender.