Credit Scoring: Making the Grade

Credit scoring, around since the 1950's in such industries as bankcards and auto lending, has become a prevalent wave of mortgage credit underwriting. Founded by two men named Bill Fair, a mathematician, and Earl Isaac, an engineer, credit scoring has become known to us today as the FICO score. Simply put, credit scoring is used as a "snap shot" to determine how your past credit performance will affect your future performance.

Secondary mortgage market lenders, Fannie Mae and Freddie Mac (federally chartered corporations that are the largest purchasers of mortgages in the United States) require lenders who expect to sell their loans in the secondary markets to use a borrower's credit bureau score. As a component in their automated underwriting systems, both agencies use a credit score to obtain a credit decision. Private mortgage insurance companies are also following the endorsement of scoring and have adopted the system as a way to forecast mortgage delinquencies.

It's important to distinguish between a credit "report" and a credit "score". A credit report is a listing kept by credit bureaus of credit data such as credit card accounts, mortgages and other loans and it details payment behavior for each account you hold. On the other hand, a credit score is a statistical analysis of credit-related data that produces a single number or score. In mortgage lending, credit scoring is used as a tool to remove bias and summarizes in a number the relative likelihood that an individual will repay the loan.

A credit bureau score evaluates the information in a consumer's file at a credit reporting agency. As an index, the score reflects the relative risk of serious delinquency, default, foreclosure or bankruptcy associated with a borrower.

Evaluated are such items as:

• Past credit delinquencies or derogatory payment behavior
• Current level of indebtedness
• Types of credit
• How often credit is applied for and credit lines opened

The information considered in the scoring process is contained in an individual's credit file. They do not consider a persons employment, income, savings, or down payment amount. Scores are available from the three major repositories: Equifax, Trans Union, Experian, and TRW. They range from the 300's to the 800's and they are calibrated to indicate the same level of credit risk regardless of the repository.

Overall, many lenders are using the scores as one element in managing risk. As an example, scores over 660 merely confirm the borrower's willingness and ability to repay as agreed. Between 660 to 620, they consider all aspects of the credit history to establish the borrower's willingness and ability to repay as agreed. With scores less than 620, lenders must cautiously review all aspects of the borrower's history to ensure that they have satisfactorily established the borrower's willingness and ability to repay as agreed.

Credit scoring is not used to replace prudent underwriting performed by a seasoned professional when reviewing an entire loan package. When effectively used, credit scoring can be highly useful in managing an important function of one component in the entire mortgage application process. The ability to sum up credit performance via a statistical analysis allows us to better manage workflow. We can identify and streamline loans that will likely need less underwriting and free-up time for good loans that need more. For you, this translates into a faster loan approval.

For more information on credit scoring and to find out how you can make the grade, contact your DKMC Mortgage Planner today.