Until l993, mortgage lenders had traditionally relied on underwriters to determine if a borrower was worthy of a mortgage loan. The underwriter would mail out employment and bank verifications, order a credit report and review each piece of information when it was received. The underwriter or loan committee would meet to determine if the borrower met the guidelines established for the type of loan he was applying for. This process would often take weeks or even months to gather the information and make an underwriting decision. In today’s fast paced market, lenders want to be able to make decisions within 24 hours, if possible. So lenders have had to change the way mortgage loans are underwritten.
One of the first changes made to speed up the underwriting process was to accept verifications of employment through pay stubs, rather than written verifications through the U.S. mail. Likewise, bank statements have replaced the need for written bank verifications. Court papers and canceled checks are often used as proof of additional income sources such as child support or alimony. Next, credit reports started coming with credit scores.
Credit scoring is an numeric way of weighing various financial factors, like income, debts, job history, credit history, and other factors, which can help predict the likelihood of the borrower defaulting on the mortgage. While there are a number of credit scoring models used, most lenders seem to use the Fair, Isaac & Co. (FICO) score that ranges from 450 to 900. The lower the score the higher the risk. Credit scoring is now part of the credit report that the lender gets when a borrower applies for a mortgage.
The formula for the Fair Isaac creditworthiness score deals only with financial information about a borrower and doesn’t consider such factors as place of residence, age, race, sex or nationality. The score is developed by giving weight to the following areas: Record of timely payments on loans-35%, the amount and type of outstanding debt-30%, length of credit history-15%, the mix of credit accounts-credit cards, department stores, finance companies, bank loans-10%, number and types of accounts opened recently-10%.
While the credit scores have some merit, there are different systems of scoring and the borrower may actually have three different credit scores at the three major credit bureaus. This is why FNMA recommends that lenders obtain credit scores from two of the three major credit bureaus and compare the scores. The lower score is used when only two scores are obtained. The middle score is used if all three credit bureaus are used.
While the credit score is only a tool to help lenders determine their risk, FNMA conducted tests on one million loans and found that one in eight borrowers with a FICO score below 600 were either severely delinquent or in default. On the other hand, borrowers who had a FICO score of 800, only one in 1300 borrowers were severely delinquent or in default.
While individual lenders are allowed to set up their own requirements for credit scores and there are no established guidelines, most lenders seem to generally agree on the following grading system:
CREDIT SCORE RATING
760-850 A++ This category is reserved for superior financing options such as 125% loans.
700-759 A+ This category is reserved for 100%, 103% & 107% conventional financing.
660-699 A This category entitles borrower to the “prime interest rate”.
620-659 A- This category is where “subprime loans” may begin, depending on all facts.
580-619 B This area is definitely “subprime”, the lower the score, the higher the rate.
579 & below C-D This is the lowest category that most “subprime lenders” offer mortgages.
When a borrower’s credit is in the “A” range they are entitled to the going rate on 30 year fixed rate mortgages and high ratio loans such as 95% conventional loans. If their credit scores are in the A+ or A++ categories, they may be entitled to even higher ratio loans, such as 100%, 103% or 107%, which requires less cash outlay. “A-“ borrower’s pay .5%-1.0% interest more than the going rate for 30 year fixed rate mortgages. “B” borrower’s pay 1.0%-2.0% more than the going rate for 30 year fixed mortgages. “C” borrower’s pay 2.0%-3.0% more than “A” borrowers and so on.
