Your Credit Score... the Good, the Bad and the Ugly

How many of you have been told "your scores are great", or "if your score were 10 points higher, you could get a better rate?” Most consumers have been faced with some kind of credit issue.



The early creators of the underwriting process felt that, buying a house should be as easy as buying a car. After-all, houses are attached to a foundation, they usually appreciate and people usually live in them. Using that logic, the industry should be able to make the home buying process easier for everyone.



The theory sounded good, and within the last year there has been some relief from the mountains of paper that go into loan files, and it is because the credit scoring models have become more refined. Scoring models figure prominently in the future of how people obtain home mortgages.



Most people know that most creditors use credit report agencies for obtaining information on a person when they have applied for any type of financing. There are three major repositories of credit and background information. They are Equifax, Experian and TransUnion. When someone obtains credit, the creditor reports the payment history to these repositories. This is usually done monthly but may be done on an irregular basis. These repositories simply accept the information as it comes in electronically and they DO NOT check the accuracy of the information.



The credit repositories and other agencies also maintain other background information on every person in the country who has a Social Security number or other identifying information. The other agencies may include the Department of Motor Vehicles, the Medical Information Board, the FBI, local law enforcement agencies, the county recorders for each county (public records repositories), etc. Even the mortgage industry has a central repository for borrowers and lenders who may have been involved in fraudulent activities in the making of mortgage loans.



When you apply for a mortgage, your lender will request a credit report from a credit reporting company. This is usually a local or regional company. This company pulls together a credit report electronically. It usually comes from one or more of the major repositories, but it can come from several sources.



Along with the information, the local credit reporting company receives a numerical score. The score represents a composite of the borrower's credit history, employment, ability to save, and so on. The most famous of these scores is known as the FICO score, which was a model developed by the Fair-Isaacs Company a number of years ago. It is believed that the Beacon and TransUnion scores are really scoring information provided by the Fair-Isaacs Company, but have been tweaked somewhat by the other bureaus. That is partly true, but what most people don't know is that, with information streaming into their credit file almost everyday, the scores can change daily. That is why someone can apply for a mortgage with one company today and have a FICO score of, say, 717, and apply with another lender a week later and that score can be higher or lower, depending on the information received at the repositories in the interim.



The truth is that the Fair-Isaacs Company and the major credit repositories do not divulge how the scoring model works. Due to the level of erroneous reporting to peoples' credit files, there has been pressure on Congress lately to make the credit repositories more accountable for the accuracy of the information they report AND to divulge what goes into the scoring models, so that people can know what to do to improve their scores.



Why is this important? The lending industry is moving toward "risk-based" pricing. In plain English, this means that the higher one's credit scores, the less paper they will have to provide to prove that they are creditworthy AND the interest rate and/or fees a borrower pays will be based on the level of their scores.



This system, while perhaps unfair to some, will be great for those who maintain impeccable credit. It's one way that good credit risks can be rewarded. In the past year, we in the industry have already seen a dramatic reduction in paperwork requirements and "risk-based" pricing (rates and fees) has become commonplace.



If you have recently obtained your credit report and you are not happy with what was reported, you can take steps to correct the erroneous information on it. There are also proactive things you can do to improve your scores, if you are anticipating applying for a mortgage anytime soon. I intend to go into the details of correcting erroneous credit information in Part 3 of this article. Look for that information in two weeks.