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850 750 800 A No-Nonsense Guide to Understanding Credit Scores 2 Introduction C

850 750 800 A No-Nonsense Guide to Understanding Credit Scores 2 Introduction Credit and credit scores are more important than ever before. More restrictive credit and underwriting standards have kept thousands of military members from purchasing or refinancing a home in the past two years. VA-approved lenders nationwide have ratcheted up their requirements in the wake of the subprime meltdown. Qualified borrowers can still purchase a home with no money down, but veterans and active duty service members without a solid credit score are finding it tough to secure financing. Lenders might start to loosen up a bit in the coming years, but in most cases a more conservative approach to home lending will continue to define the industry and govern the path to homeownership. For America’s service members, the reality is both stark and simple: Building a solid credit profile is more crucial than ever before. This guide aims to help borrowers do exactly that. Credit Scores and Homeownership There was a time when obtaining a home loan involved little more than a handshake with your local banker. After all, he was probably your aunt’s neighbor and served on the PTA with your brother-in-law. He knew if you were a good credit risk, just like you knew that he mowed his lawn every Saturday. Those days are long gone. Today, lenders scrutinize a prospective borrower’s credit score and overall financial profile. Your three-digit credit score helps determine your inter- est rate, your monthly mortgage payment and whether you can qualify for a home loan in the first place. Credit requirements and standards are getting tighter by the day. VA lenders avoided the kind of risky lending that helped trigger the nation’s economic collapse. But all borrowers are paying the price. 850 750 800 Equifax • Experian • TransUnion Each of the three credit agencies has its own scoring method, and there’s a fourth — the VantageScore — that the trio created together. What is a credit score? A credit score is essentially a measurement of a borrower’s willingness and ability to repay debt. Borrowers build up their credit profile by selectively using credit and repaying it on time each month, along with other key factors we’ll discuss shortly. But when people talk about their “credit score,” they’re most likely talking about one scoring model in particular, the FICO score. This mathematical algorithm comes from the Fair Issac Corporation, or FICO, a California- based company that also created the first-ever credit score. FICO scores run from 300 to 850. They are calculated using a complex web of factors, some 20 in all, broken down into five broad categories. For consumers, that’s a lot of credit scores to worry about. Scoring ranges for the different methodologies vary. The companies that extend credit to borrowers report their monthly transactions to one or more of the nation’s three credit reporting agencies: 3 What is a Good Credit Score? There’s no national cutoff or score range that lenders are required to use. One lender might offer a lower interest rate to borrowers with a score of at least 690. Another lender might require a 710 score in order to qualify for a better rate. “Good,” much like “Beauty,” is in the eye of the beholder. Or, in this case, the eye of the lender. But there are some general trends borrowers should consider. To get the best rates and have the most favorable conditions for financing, your score should be well above 700. Those with scores in the upper 600s will still have plenty of options, but there are very few products for borrowers with credit below 620. Veterans and active duty service members will likely need a credit score of at least 620 to se- cure a VA loan. These flexible, low-cost loans have helped more than 18 million veterans become homeowners since 1944. Qualified borrowers can buy a home with no money down, no private mortgage insurance and with consistently better rates than conventional loans. But why stop at 620? The higher your credit score, the more money you will save as you qualify for great rates and terms on all kinds of financing. There’s also no guarantee that requirements will loosen. In fact, they could easily get even more restrictive. VA loans also provide military borrowers with greater flexibility than other loan types. A pro- spective borrower with a 620 score will almost always get considerably better rates on a VA loan than on a conventional loan. Credit Score Percentage 499 and below 1 percent 500-549 5 percent 550-599 7 percent 600-649 11 percent 650-699 16 percent 700-749 20 percent 749-799 29 percent 800 and above 11 percent FICO slices its score range into eight categories. Here’s a look at the breakdown of scores by percentage of consumers: 4 Credit Scores and Securing a VA Loan The Department of Veterans Affairs doesn’t have a hard and fast credit score requirement for service members to participate in the program. Instead, the VA looks at a host of factors to determine whether a veteran is a satisfactory credit risk. Flex- ibility is a cornerstone of the program. But that’s not the whole story. Lenders use their own credit standards and guidelines to evaluate loan applicants. That’s a fair practice, considering VA lenders assume most of the risk when they finance a home purchase or a refinance. Thinking beyond up-front payments: Keep “reserve” funds available when purchasing a home It’s certainly important to make sure you have funds available to cover the up-front costs of a VA loan. What’s even more important? Making sure you have an emer- gency stash of housing funds available. These funds can be your saving grace if disaster strikes, protecting you from the devastating effects of foreclo- sure. Lenders also like to see that you have reserve funds avail- able. In fact, some lenders require that a borrower have at least two months of mortgage payments in “reserves” before they will issue a loan. Think ahead and protect your home investment. No hom- eowner wants to deal with the headaches of foreclosure, so al- ways try to have a few months’ of mortgage payments squir- reled away. Here’s a look at the basic standards you’ll have to meet for a VA loan: • You must have a credit score of 620 or higher. Several years ago, the requirement was 580. Then it was 600. Now it is 620, with some lenders even using a 640 benchmark. • No foreclosures or Chapter 7 bankruptcies in the last two years. Lenders follow the VA’s guidelines here. Pro- spective borrowers must wait two years after foreclosure or bankruptcy. Some exceptions may be made for Chapter 13 bankruptcies, but they are rare and on a case-by-case basis. • You must be able to docu- ment a sound credit history. Borrowers can do this through a credit report or through alternate credit sources. If you do not have three open and active accounts on your credit report, a lender will most likely require you to show some other forms of credit. These may include utility bills, monthly subscriptions or pretty much any account requiring monthly payments. 5 How is My Credit Score Determined? The credit agencies and FICO have not publicly revealed their entire formula for creating a credit score. But they do provide consumers with a clear explanation of those five broad categories that shape your score. Payment History (35 percent of your score) Late payments are penalized in tiers by 30- 60- and 90-day increments. They can reduce your score significantly, which may tip the scales between qualification and rejection for financing. Depending on your FICO score, a 30-day late pay- ment can cut your score by as many as 110 points. Amounts Owed (30 percent of your score) This section looks at your debt and weighs it against your available credit. In order to get full points here, you’ll want to keep your revolving debt bal- ances (like credit cards) below 25-30 percent of their limits. Length of Credit History (15 percent of your score) This factor tends to penalize young bor- rowers who have only recently estab- lished credit. A lengthy history agives credit bureaus a good feel for your usage and responsibility, so keep your old accounts open. New Credit (10 percent of your score) This looks at the number of recent credit accounts and inquiries that are on your report. If you’ve just opened seven new credit cards, your score will go down for a while until your payment patterns are estab- lished and documented. New credit can help your scores, too, as it makes a big difference to show healthy credit after past derogatory activity. Types of Credit Used (10 percent of your score) If you’ve only ever used department store credit cards, you’ll get a lower score here than someone who can show a credit card, a student loan, an auto loan and a mortgage that were all paid on time. The scoring models cater to uploads/s1/ guide-to-understanding-credit-guide.pdf