Navigating The Five C’s

New Year is a good time to review what makes up a good credit profile

Rob Chrisman
Rob Chrisman
Navigating the 5 C's — Credit Score

Under Dogs

Underwriters who look at credit, and credit reporting agencies, are quick to tell you that there are additional components that are reviewed and can have an adverse effect on credit so it is very important that a borrower makes sure a credit report is accurate. Public records will report public items such as bankruptcies, foreclosures, or tax liens. Collection accounts, such as medical bills or other bills, that a bill collector or creditor can place on your record for past due payments will appear on reports issued by Equifax, Experian, and TransUnion.

Underwriters also look for charge offs occurring for credit cards that have fallen beyond the window of repayment. The remaining balance will show as an arrearage which will adversely affect anyone’s credit and credit scores. And credit inquiries pulled in a certain timeframe usually won’t hurt credit scores but multiple inquires over longer periods of time could affect credit: Excessive inquiries can cause a red flag for lender.

Many years ago the Fair Isaac Company created an easy-to-use FICO score as a single number for comparison purposes. The score is comprised of a borrower’s payment history (35%), amount owed (30%), length of credit history (15%), new credit (10%), and credit mix (10%). Scores range from 300 to 850. Many lenders have a minimum FICO score you need to meet before you’re eligible for a loan, and the higher the score, the more likely a borrower will qualify for the types of mortgages at the best price.

One of the most important qualifiers (though not the only one) for a mortgage, and for getting the best program options and terms, is having a good credit score. The average national FICO credit score is actually over 700. But how good of a credit score does one need to buy a house? Generally, credit scores above 800 are considered exceptional, those between 740 and 799 are very good, and those between 670 and 739 are good. Anything below 669 is seen as either “fair” or “very poor.”

The credit score needed to qualify for a mortgage can vary depending on the loan program, lender, and other criteria. The higher the credit score, the more choices borrowers have when it comes to loan programs and qualifying. For a standard FHA loan using traditional credit, a credit score of at least 500 with a minimum of 10% down, or at least 580 for the minimum down payment of 3.5 percent. Some lenders may impose “credit overlays” and that require a higher credit score such as 620 for FHA loan eligibility. A borrower’s credit profile plays a big role in determining what type of house they can own.

Navigating the 5 C's — Credit Measures

Factoring Fixes

But what about the other factors in evaluating a borrower? The score is comprised of a borrower’s payment history, amount owed, length of credit history, new credit, and credit mix. “Character” helps lenders determine a client’s ability to repay a loan, usually determined from the credit report. Payment history is improved when a borrower pays bills on time, often through setting up automatic online payments for debts. They can also pay down existing debt or use a co-signer with good credit when applying for a loan.

Capacity measures the ability to repay new debt based on current obligations. Here, cash flow is paramount, along with debt-to-income ratio. Lenders want to know how much is owed versus how much the client owns. The lower the debt-to-income ratio, the more favorably a bank will look at the request for credit. Other considerations include length of time at your current job and income stability. Typically, banks look for a debt-to-income ratio of less than 36% as an indicator that a borrower is responsible with credit. If a client has low capacity due to a high debt-to-income ratio, paying down debt is a good strategy.

Capital is an indication of seriousness and commitment in the form of a down payment when applying for a loan or mortgage. Collateral provides assurance to the lender in the event the borrower defaults. If a potential borrower doesn’t have collateral, MLOs will often encourage the introduction of a co-signer. This is a person who has collateral to back the loan. Conditions refer to the current economic health of the market and the industry that the borrower is in.

To wrap up, homeownership may be something a client has dreamed of for much of their adult life. An originator can add real value by making sure your borrowers have a good credit score that can help them afford the house you want. Bottom line for someone financing a home? Establishing a credit history is not hard, but it takes a little time to build. Start with one or two credit cards, make timely payments, and build from there.   

Rob Chrisman
Rob Chrisman

Rob Chrisman began his career in mortgage banking – primarily capital markets – 35 years ago. He is on the board of directors of Inheritance Funding Corporation, of Doorway Home Loans, of AXIS Appraisal Management, and of the California MBA. He is also a member of the Secure Settlements Advisory Board, an associate of the STRATMOR Group, and of the Mortgage Bankers Association of the Carolinas and its membership committee.

This article was originally published in the Mortgage Banker January 2022 issue.
Published on
Jan 04, 2022
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