There’s nothing like waiting by the phone to hear whether or not your loan application has been approved. That’s a good thing, since home buyers are generally nervous enough.
But if more folks knew that approval for a mortgage applications rests on a mathematical computation known as a credit score, antacid sales might skyrocket.
One of the better-kept secrets in the finance industry that mortgage lenders and prospective creditors treat your credit report as a running scorecard of your financial life. When you apply for a credit card, auto loan, or mortgage, lenders take your credit report and run it through a mathematical program called a “credit score.” They assign points (positive and negative) to different information (called tradelines in industry jargon) in your file to determine if you’re a good risk.
Credit scoring programs analyze your mortgages, personal loans, student loans, auto loans, judgments, and credit card debt, and payment history. But they also look at the total number of credit cards and credit accounts you own, and at your level of debt relative to your income. Do you have too many credit inquiries? Do you have a checking and a savings account? Having a checking account but no savings account might sink your credit score right then and there, experts say.
Today, many creditors claim to use proprietary guidelines to see if you pass financial muster. But the most common system was created by Fair, Isaac & Co., a San Raphael, California-based data-management services and consulting company. Their credit scoring method is nick-named “FICO,” and it assigns you a credit score between 300 and 900, with most consumers getting between 500 and 800.
Each creditor then determines which number will be the cut-off bottom line for their applicants.
The idea behind credit scoring is relatively simple. In years gone by, the corner grocer or clothing store owner knew everyone in the neighborhood. If someone wanted credit, you’d already know them and their financial situation and you could make an informed decision.
But there’s little room for that kind of “know thy neighbor” intimacy in a global marketplace. Credit scoring is supposed to help lenders and creditors objectively decide to whom they should extend credit. The problem is, credit-worthy people sometimes get rejected while individuals who are horrible financial risks get approved. The old clichÃ©, “life isn’t fair,” applies.
Since the federal government hasn’t yet seen fit to regulate credit scoring (though the Justice Department is supposedly reviewing the practice), it’ll be tough for you to know whether or not you’re going to have a problem getting approved for credit until you’ve actually applied. If you have a lot of negative information on your credit report, and you’re applying for something big, like a home loan, chances are you’re going to have problems. In that case, you may be better off taking six months to fix your credit before you apply again.
Whatever you do, don’t keep applying for credit once you’ve been denied. You’ll just add more negative information to your credit history.
While all this sounds scary, credit laws are constantly changing, often to the consumer’s benefit. A recent change gives consumers a 30-day window to shop for a mortgage. That means you can have a 30-day window for unlimited mortgage-related inquiries without it sounding a warning bell. For all other loans, you now get a 14-day grace period. So if you’re buying a car, you’ll want to shop for your financing within 14 days.
Still, getting rejected for a loan hurts, especially if you feel as though your credit is good. And, it’s hard not to take the rejection personally.
But make sure you ask the creditor why you’re being rejected. You have up to 60 days to get a free copy of the credit report provided to the creditor if you’ve been denied credit. Under the Equal Credit Opportunity Act (ECOA), the creditor must tell you why you were rejected, though they are not required to tell you the factors and points used in its scoring system.
Use the information to clean up your credit, or improve weak spots. For example, if you’re rejected because you’ve only been at your job a short while, you can wait until you’ve been employed there longer.
Is credit scoring here to stay? It’s painless (to creditors), bloodless (again, to the creditors), and color-blind. That probably means we’re going to get stuck with it. Fortunately, what’s a failing score to one lender might be a passing grade to another.
May 4, 1998.