Do you know what makes up your credit score?
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Once upon a time, it used to be that a person with a credit score of 640 could refinance their mortgage and pretty much be assured of getting the best rate on that mortgage. Unfortunately, those days are long gone.
The mortgage credit crisis of 2007 and 2008 resulted in nearly every mortgage loan source redefining “good” credit to mean a credit score of at least 680 and usually 700 or higher. Up until 2010, those credit scores were considered excellent but they have become the minimums just to qualify for many programs.
The one exception to these new rules is the FHA mortgage refinance program, which still defines good credit as any credit score above 640. In addition, borrowers with credit scores below 640 may still qualify for an FHA refinance mortgage loan if their loan is approved through the automated underwriting system.
The FHA loan program can help borrowers with lower credit scores, but that program does come with mortgage insurance which does add to your monthly payments.
If you have less than 20% equity in your home when you refinance, then it definitely makes sense to use the FHA program to refinance if your credit score is below 700. Private mortgage insurance costs have increased dramatically for borrowers with credit scores below 700. In many cases it is not even available (e.g. for three and four unit properties). Also, private mortgage insurance qualifying requirements are so high right now that even the most qualified borrowers are having trouble obtaining private mortgage insurance.
One option if your credit score is between 640 and 680 would be to work with a credit agency to find out why your score is low and take steps to get your credit score to a level above 680. The good news is that this process used to take months but now only takes weeks. One word of caution, however: while there are many legitimate credit repair agencies there are also a number of less-than-scrupulous companies.
For now, and the foreseeable future, 680 is the minimum credit score needed to refinance with Fannie Mae or Freddie Mac without having to get hit with a higher interest rate, and the FHA program is probably your best bet if your score is below 640 – especially if you are borrowing more than 80% of the value of your home.
Do you have a low credit score? If so, you’re not alone. Thousands of Americans, buffeted by the recession, are facing lower than average FICO scores. Since most Americans have, on average, a credit history of 14 years and 13 credit obligations, the capacity for error can be great. In fact, since the average American has approximately $19,000 in credit to manage, it helps to know how you can avoid getting lower credit scores, or how to improve your existing one.
In this article, we discuss how bad credit happens and what steps you can take to repair your low credit score.
How Bad Credit Happens
More than 25% of Americans have credit scores below 600, which is commonly referred to as the dividing line between good credit and bad credit. How do they get into this predicament?
There are four steps most consumers take on the road to poor credit:
- Overuse of credit – the higher your balance, especially relative to your credit limit, the lower your credit score will be.
- Late payments – a single late payment (over 30 days late), can dock your credit score by as much as 110 points.
- Debt management tactics – short sales, deeds in lieu of foreclosure, settlements, and other debt reduction practices can decrease your credit score by as much as 85 to 160 points. Bankruptcy can drop your score another 130 to 245 points.
- Actions by the credit card issuer – your credit scores will fall if your lender cuts your credit limit or pursues any collection activity.
Understanding Credit Management
It’s important to know there’s a right way and a wrong way to manage credit. Less than 50% of Americans have ever been 30 days late on a payment, but 30% have been 60 or more days late, and 20% have had an account closed by the creditor. So obviously proper credit management practices should be implemented by at least half of all consumers who are using credit.
Credit utilization in the United States breaks down in this way:
- 40% of credit holders carry less than $1000 balance on their accounts;
- 48% carry approximately $5,000 or less as a balance;
- 37% carry less than $10,000 in non-mortgage related debt;
- 15% carry more than $10,000 in debt.
Repairing Credit – What You Should Know
You can repair your credit score by taking the following actions:
- Pay all your credit card and other bills every month;
- Begin paying down your high credit card balances;
- Exhaust all other avenues before allowing foreclosure to happen or declaring bankruptcy.
Repeatedly requesting your credit report can lower your score. Be sure to challenge any false or incorrect information on your credit history, which you can obtain by getting your free credit report on an annual basis. The total amount of credit you have isn’t really what counts; instead, lenders look at your available credit when calculating your score. If you want to repair your credit, a debit card won’t help your score, but it can help to rein in your spending habits.
If you spend any time on the Internet, you have surely seen the many ads offering free credit scores. It sounds like a good deal, except credit scores are never really free. You will pay one way or the other. To get your rating from one of these companies, you will have to sign up for one of their services, usually a credit monitoring service. That is not necessarily a bad idea. It can help protect you from identity theft, and alert you to credit checks by businesses that want to offer you a pre-approved credit card or loan. But, it’s never really free.
If you do not want to join those programs, you can pay for your score on the FICO website. The only time you can get free credit scores, and the reason why you do not want them, is when a lender denies you credit. A new law going into effect in mid-2011 requires lenders to send the applicant their credit score when they deny their credit due to a low rating. This is a good thing for consumers put in that unfortunate position, as it will eliminate all of the mystery surrounding a consumer’s credit rating.
Don’t confuse free credit scores with free credit reports. You can get a free report once per year from all three reporting agencies. You can also get a free credit report anytime someone denies you credit. Just contact the reporting agency, and they will mail you one. The report doesn’t show you your credit score, but it does give you a lot of good information about your credit history.
Your best bet is to maintain the finest credit history you can. If you have a great rating, you will be approved for most loans. If that happens, you won’t get free credit scores. That is a good thing. If you must know your rating, you can go ahead and pay to get it.
When you ask for a loan from the bank, they look at more than just your credit score.
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