How to Navigate New Credit Score Tool for Mortgages
Lenders have a new tool at their fingertips for evaluating the credit worthiness of home loan applicants. It's called FICO 8, the eighth generation of Fair Issac Corp.'s formula that's used by most lending institutions to access credit risk. But the latest version has one twist: Its touted as being at least 15 percent more accurate in detecting risky mortgage borrowers.
"[The FICO 8 Score] will have little impact on the credit worthy consumer," says Mike McGervey, president of McGervey Wealth Management in North Canton, Ohio. "But it will be a heightened source of awareness for borrowers who are less credit worthy."
The average consumer should expect to see their scores fluctuate roughly 10 to 30 points in either direction, he adds. Though, depending on individual credit histories, some individuals may be at risk of seeing a more drastic plummet or even have the advantage of a seeing a slight bump.
A lower credit score also translates to higher interest rate costs. According to FICO, a 100-point variation (on a 30-year mortgage of $300,000) means $40,000 in extra interest payments over the life of the loan.
With higher interest rate costs and most lenders requiring a credit score of 620 or higher (out of 850) to issue a mortgage, every point counts when buying a home. So here's what you need to know about the changes implemented to the FICO score and how to keep your credit score --and pathway to home ownership-- on the right track:
1. Your credit usage matters more now. Roughly 30 percent of your credit score is already based on the amount of debt you owe, but the new calculation is likely to be more sensitive to people with high credit card balances. This is a red alert, says McGervey, because it demonstrates borrowers don't have the adequate cash flow to pay off their current balance and service new debt, such as obtaining a mortgage or a car loan.
2. You may be forgiven for an isolated missed payment. Borrowers with a generally strong credit history will not be as heavily penalized for a one-time missed payment (determined by being at least 30 days late) compared to previous versions of the score. However, if this behavior becomes a repeated pattern, then your credit score will likely take a bigger hit than in the past.
3. Your score may be negatively impacted by "piggybacking." According to FICO.com, there's been no changes in "helping people benefit from the shared management of a credit card account." However, some reports say that FICO's most recent edition is sophisticated enough to distinguish between account sharing between close relatives, such as a husband and wife, and the more objectionable practice referred to as "piggybacking." That's when a primary cardholder -- in good standing-- adds someone as a authorized user to their account for the sole purpose of helping them benefit from the positive credit history and begin to build their own credit.
Get Your 2010 Credit Score
Do's and Dont's for Prospective Homeowners
It's just as important as ever, says FICO, to pay bills (even if it's just the minimum) and to pay the due amount in a timely fashion. In addition, FICO advises only opening a new credit account as absolutely necessary.
Generally, it's also a bad idea to close credit card accounts (that lowers your credit limit which in turn increases your debt-to-limit ratio), but McGervey says if a credit account has to be closed, it's preferable to cancel cards with less history. "If you have a lot of credit history and carried a card for 5 or 10 years or longer, that's worth a lot to the credit bureaus and scoring agencies," he says.
But Chris Hogan, a financial coach for The Lampo Group, Inc., has a more aggressive remedy for prospective homeowners. He advocates that borrowers reduce debt, stop using credit cards, and save a greater percentage of their paycheck for a down payment, so they can become less dependent on their credit score in the future.