Apply for a mortgage loan and one of the first potential obstacles to overcome is your FICO score. This three-digit number can translate into hundreds of dollars of difference in your monthly payment, and can potentially block you from finding a lender to fund your loan. Fortunately, you do have the ability to improve your FICO score. Even those with superior credit can benefit.
First of all, what does FICO mean? FICO is an acronym for FAIR ISAAC AND COMPANY. This firm uses a proprietary formula which calculates a three digit number, between 300 and 850, which lenders review when you apply for credit. The number represents the potential risk you present to a lender.
Five primary factors are used to calculate your FICO score, although the exact formula is quite secret. Most people who try to estimate the weight of each factor are really taking an educated guess at how the number is derived. However, the five factors are derived from your credit report, then plugged into the formula.
When you apply for a loan, the lender will run a copy of your report and immediately check the FICO score. This number then lets lenders gauge whether you would be a good risk in a credit situation. If you have a score of 700 or more, you are generally considered among the `gold standard' of borrowers. If your score is 600-700, your credit application might be scrutinized more fully or rejected outright.
The FICO scoring index may not fairly represent your personal credit situation. Unfortunately, lenders often don't look at people, just numbers. And while a raw score does
not mean you have problems and it does not mean you are a candidate for higher rates, in the minds of the lenders, a low score requires more analysis - perhaps more than they are willing to invest. By taking control where you are able, you can influence your FICO score for the better.
THE FICO FIVE
Here are the 5 categories, and their corresponding values, that comprise FICO:
|· Your credit payment history
|· Your outstanding debt load
|· Your length of credit history
|· Your mix of credit
|· Your number of inquiries
The most important aspects of your FICO are how much you have in debt and how you handle your debt load. Too often consumers and business owners become top heavy with debt. While they may not be in imminent peril of bankruptcy, they may struggle to make just the minimum monthly payments. One lean month could topple their `house of credit cards' and new lenders, or even those currently lending to the client, may try to eliminate that borrower from their portfolio.
65% of your FICO is determined by these two factors. When a lender reviews the report, a top heavy debtor could be declined or be subject to higher interest rates or reduced credit limits.
The third factor is length of credit history. If you are young or a recent borrower, you may not have enough credit history to give FAIR ISAAC AND COMPANY a handle on your
borrowing or payment habits. A simple solution is to establish some credit payment habits with small purchases paid on time.
Your credit mix is the fourth factor. What this measures is the type of credit you have - not the amount of debt, just the potential for it. In other words, if you have a large number of open credit cards, auto and consumer loans, you may be considered a risk. Lenders know the temptation to use those cards that have been sitting in the wallet, purse or drawer. They may have zero balances now, but overnight this instantly-available credit could explode. The solution here is to cancel all those unused cards and get a much more stable, fixed rate mortgage and a couple of credit cards.
If necessary, obtain a refi loan or line of credit on your home to reduce or eliminate the larger credit balances of the obsolete cards and those consumer loans you are now paying at higher rates. If you reduce your consumer debt by using your home mortgage you not only reduce your monthly out go and get a typically deductible interest loan, you can really improve your rating. Just don't go out and charge up the cards again.
The final factor is the number of inquiries on your credit report. Is 5 too few? Are 30 too many? It depends on your situation and whether you are a business owner or a typical consumer with a home loan, one car and a couple of credit cards. But what you can see is that it does not pay you to go out and frenetically apply for credit. That could really hammer your score because it could immediately increase the score against inquiries and drop your FICO rating. Plus, any lender seeing this number may cast doubt on your credit worthiness and the wisdom of `shot gunning' applications.
Your FICO score can mean a $500 a month difference in your mortgage payment. It can mean not getting credit at any price. It can increase your auto loan rate from the premier 0%
to 9-12%. It can spell the difference in getting a preferred home, auto, life or business insurance rates. Yes ... insurance firms also study your FICO. If you are not responsible in your payment habits, you are probably running risks in your life that are costly to you and your insurance carrier. Like it or not, in the vast survey of people and their habits, lifestyle choices make a difference.
FIX YOUR FICO
If you believe you have done everything right but still have a low FICO score, remember the credit agencies information that goes into the FICO calculation may contain errors, inaccuracies, gross distortions, or false and misleading material. These are terribly common and you would be amazed how this can change your score. You would be wise to check your credit report at least once a year. There are services available to do that, but you can do the work yourself by calling the three agencies and ordering their consumer-friendly reports. You then review the data for the above mentioned items and send a letter asking the agencies to change or correct the data. You can correct false, inaccurate or old and misleading credit payment incidents.
Once you have combed out the junk information, then go through and ask the agency to remove credit inquiries you did not authorize. Credit agencies can't just poke through your report at will. There are serious penalties for those that do so and these lenders, marketing firms and credit card companies must ask your permission to do so.
To get your score to its highest level, cancel all but a couple of your credit cards. This adjusts the credit mix and puts more emphasis on your home mortgage rather than the volatile, shortterm credit and shopping card debts.
If you are shopping for loans now, you can increase your score quickly while getting better rates by following the previous suggestions, and working with the lender to improve your
budget, reduce your consumer debt and get better terms on the existing home debt. This is really the `trifecta' of debt consolidation and FICO score improvement. This process may take several months to complete. Taking out inaccurate information can be done within a month or two with the investment of a couple of hours of your time. If you do dramatically revamp your credit structure and FICO score, it may take a year and some real patience, budgeting and foresight. But just keep in mind, $500 savings on a $250,000 mortgage is $6,000 a year. That is $60,000 over a 10 year period.
If your score is 700 or more, you may need nothing more than a `fine tuning'. A safety margin of 30-50 extra points on your FICO is also advisable. A simple cursory review of your three reports to determine if they are accurate may do the job. If you are in the 600-700 range, there is much more room for improvement. Finally, if your score is under 600, you may need the services of a credit counselor. If you choose to go it alone, our advice is to spend some real time evaluating your situation and try to correct the payment habits you have today for those that will be more highly regarded in the future. You can change your FICO up to 100 points in a year by following the steps mentioned here. Even with a low FICO, the steps will bear results if you stay with them. It will take time, but since you spent years getting to the point you are today, another year is not much time to invest in this improvement.
If you plan to go for a business loan, particularly an SBA loan, the situation can be very different. In the business lending field, the bank is not driven by FICO score. If you are in business now, your FICO could easily be in the 620-680 range and you have perfect credit. The problem isn't your payment record. It typically is commercial creditors putting your business loans into your personal credit report, inflicting your report with multitudes of inquiries and skewing your personal credit mix and debt load in the much more sensitive personal credit report.
Remember, 65% of the FICO score is credit payment history and debt loan. With one third of the score driven by payment habits, the other two factors weigh heavily toward dropping your score. This is why the typical business lender does not find FICO to be a 'gold standard' in their evaluation. Sometimes, no matter what you do to improve your score, you can't overcome this hurdle. Don't worry. Most SBA lenders know this is true. They focus on how you pay your bills, personal and corporate, when setting your rates and determining if you are a good risk.
If your FICO score is low and not improvable in the short term, then how you pay your bills will be a hugely important determinant. The amount of debt you have is secondary in their evaluation, but one that is not overlooked. The chances of being turned down due to FICO scoring is much less because of these intangible factors. If you pay your bills on time and have a healthy business structure, the chances are good you can be approved. Not all banks think this way, but certainly many have this wider view of the credit evidence.
Don't be afraid of your credit score or report in these cases. Many businesses, when the credit scores of the owners are palpably 'sub-par', still get loans due to the important factors of business cash flow and business debt ratios.
The best way to look at this is to be certain you have a good handle on your credit score and the quality of the reports being written on you personally. If you apply for a business loan without knowing what is in your report, you could easily be blindsided by this score. Peruse your credit report before applying. If you find fault, flaws and deficiencies, remedy those items which can be corrected before applying. Those items which you cannot correct in short order must then be explained to the lender. A good clean explanation of the credit report is the best way to defuse a lender's reaction to perceived problems.