Your Credit Score and How it Affects your Loan part I

Anthony Pierpont

You may have heard of credit scores and wonder what they are. How do they affect your ability to get a loan? How do they affect the interest rate and points you have to pay? You may wonder whether your credit score is accurate. The key is to make doing business with a lender easier and more affordable. Part of this process involves making sure you are informed every step of the way. This pamphlet explains credit scores and how to improve your score.

Anthony Pierpont

A good Credit Score is something to celebrate!

What Is A Credit Score?

When lenders evaluate your loan application – a process called underwriting – they try to evaluate your ability and willingness to repay your loan. They judge your ability to repay by looking at your income and how stable your past earnings have been. This helps them to determine if you can afford the loan payments. They judge your willingness to repay by looking at your past credit history. Generally speaking, someone who has made payments on time in the past will probably do so in the future.

Lenders want their evaluation to be as accurate, objective and consistent as possible. To help achieve these goals, home mortgage lenders use credit scores to help in the underwriting process. Credit scores are numerical values that rank individuals according to their credit history at a given point in time. Your score is based on your past payment history, the amount of credit you owe, the amount of credit you have available, and other factors. According to Fannie Mae and Freddie Mac, two large investors in mortgage loans, credit scores have proven to be very good predictors of whether a borrower will repay his or her loan.

Credit scores are used to help lenders evaluate your home loan application. However, a credit score is just one of many factors lenders consider. Lenders look at the whole person. Even when a credit score is low, lenders try to find other factors that could overcome the negative credit issues and satisfy the underwriting criteria. Most lenders would not deny a loan application simply based on a credit score. The decision to approve or deny a loan application will be made based on sound, flexible underwriting guidelines.

What Is A FICO Score?

  “FICO” scores are a type of credit score developed by Fair Isaac & Company. FICO scores use credit bureau information to obtain a score which indicates how likely someone is to make their loan payments on time. Millions of consumers’ credit bureau records were used to develop score cards and all of the consumer data – not just negative information – was included to develop the system. FICO scores range from approximately 350 to 900. The higher the score, the lower the probability of default on the loan.

How Can Credit Scores Affect The Price OF Your Loan?

   Just as credit scores are one factor in determining if you qualify for a loan, they may also be a factor in determining the price of your loan. The price of a loan means the interest rate and the points charged by the lender. The price charged for a loan will be higher or lower depending on various factors.

Applicants with lower credit scores may pay higher prices for their loans because of the higher risk of default and loss on the loan. Many home loans are sold to investors, and investors will pay more for loans they feel have lower risk of default.

There are many other factors relating to an individual borrower’s situation that may also affect the price of the loan – often even more so than credit scores. These factors include:

  • type of property securing the loan (detached single family residence, duplex, or condominium)
  • amount of the borrower’s equity in the property
  • value of the property compared to property values in the area
  • the lender’s costs to make the loan and the type of loan selected

For example, a loan secured by a single family residence may have a lower price than a loan secured by a condominium because condominiums may be more difficult to sell than single family residences. Similarly, the price of a loan where the borrower has made a 20% down payment may be less than a loan where the borrower has more equity in the property because there is a greater incentive to make the payments on the loan.

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