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How do Lenders Decide to Approve a Mortgage?

When applying for a mortgage, lenders base their decisions largely on the borrower’s credit history. Each time lender draw a credit history, they run it through a computer program with a built-in score card which generates a FICO Score. Points are deducted or awarded based on certain criteria. The criteria often include whether or not the potential borrower makes his or her payments on time and how long the borrower has had credit cards or if credit card limits are maximized. FICO scores can range from the 300 to 800.

Credit scoring is an important factor in loan approval and using computer programs has made it easier for lenders to make loan decisions because all of the necessary information is calculated and readily available. It has been decided that lower credit scores require a more thorough review than higher credit scores. Some lenders may not even consider a borrower if they score below 600.

What is a FICO Score Exactly?

FICO stands for Fair Isaac & Company and is the name for the most well known credit scoring system. The credit bureau's computer weighs a complete credit history and assigns a score, which is then used to estimate credit worthiness. Someone with a higher score will be viewed as a better risk than someone with a lower score. Typical scores range from 600 to 700 or higher, although some scores do fall outside this range.

How are FICO Scores Determined?

The FICO model, commonly reffered to as the Beacon Score, has five main factors that help to determine credit worthiness of a borrower and they are as follows:

• Past payment history (35% of the score)
• Credit use (30% of the score)
• Length of credit history (15% of the score)
• Types of credit used (10% of the score)
• Number of credit inquires (10% of the score)

Your past payment history says a lot about you as a borrower. It is extremely important to have no late payments because current late payments are more detrimental to a loan application than an old bankruptcy case where the person has shown perfect credit since the bankruptcy. You should also keep in mind that paying off cards with recent late payments will not fix your credit history. Only time and making your payments on time can erase the negative effect of late payments.

The use of credit cards can get some people into financial trouble, but it is important to show that you can use credit responsibly and the longer you have an account open, the better you will score. Having low balances across several credit cards also helps your score as opposed to having fewer cards with higher maximized balances. Too many credit cards can negatively affect your FICO score, but you should also be aware that closing too many accounts can actually harm your credit profile.

The type of credit that you use will also have an impact. For example, credit through a bank or department store is better than having credit through a finance company that charges higher interest rates. Multiple inquiries can be a risk to borrowers if several cards are applied for or other accounts carry the maximum allowable balance.

Factors that Affect FICO Scores

Factors that can affect a borrower’s FICO score include:

• Tax liens
• Bankruptcies
• Delinquent payments
• No recent credit card balances
• Numerous recent credit inquires
• Legal judgments against the borrower
• Too many or too few revolving accounts
• Limited credit history (too short in length)
• Balances on credit that are near the maximum
• Numerous new accounts opened within a 12 month period
• Too many mortgage lenders running your credit reports
• Making any major purchases while looking to buy a property (e.g. vehicle purchases)

As a Borrower, How Can I Raise my FICO Score?

As a borrower, you can only change your FICO score if you change how the problematic item is reported to the credit bureau. Written confirmation from the creditor is required if you wish to change how an item is being reported. However, it is better to make changes to your credit profile before you attempt to purchase a property because you cannot guarantee how changes will impact your score.

It is a good idea to have your credit history reviewed by a professional loan officer before you start looking for a property to purchase. The loan officer can ensure that your loan is based on the most accurate and up-to-date credit information.

Remember that FICO Scores are Only Guidelines

FICO scores are only "guidelines" and there are other factors that can affect underwriting decisions when it comes to credit worthiness. Some factors that might make an underwriter more lenient towards granting a loan to a borrower with a lower FICO score can include:

• A larger down payment
• Low debt-to-income ratios
• Excellent money saving history
• Reasonable explanations for negative items on a credit history

Credit Scores and Getting the Best Interest Rate

As a potential home buyer, it is important to remember that credit scores are important if you want to get the best possible interest rate on your mortgage or even for getting your mortgage approved. Your score will also affect how much you have to pay for your loan because some lenders have a base price, but will reduce the points on the loan if the credit score is above a certain level. So it is in your best interest to protect your credit rating. Other lenders may decide to add points or costs onto a base price if your credit score is below their preferred score.