Most of the emails I have been receiving lately have been from folks who have an adjustable rate mortgage that is going to adjust on them within the next few months. The comments come from people with both subprime and prime loans; and the concern is the same: “I can afford the payments now; I won’t be able to when they change.”
I’ve put together this list of 5 things to do right now if you are in an adjustable rate mortgage so that you can better manage what needs to happen before your rate changes. I recommend starting this process at least 75 days from your adjustment date; however, if you have credit issues I recommend starting right away - regardless of your reset date.
1. Determine your rate adjustment date. Find your loan documents, determine what type of adjustable rate mortgage you have and when it is set to adjust. If you don’t know how to read your loan documents watch this video on understanding adjustable rate mortgage loan disclosures. If you can’t locate your mortgage documents you can contact your mortgage company through their customer service number.
2. Determine what your new interest rate and monthly mortgage payment will be. Here is a post on how to calculate your new mortgage payment after your ARM resets. You can find the index values here; and the 6-month LIBOR is currently at 5.1325%. If you need help with this calculation please drop me an email.
3. Determine your credit score. You can do this by running a credit report at myFICO.com which will give you your scores. Please note that Blown Mortgage is a myFICO.com affiliate and I will get a small commission if you choose this service through this site. I have been using myFICO.com for years and have been recommending it well before I received any compensation for doing so. Please read this entire series on why credit is so important to your ability to get out of your adjustable rate mortgage.
4. Determine your home value. You can do this in a variety of ways. The easiest (and least accurate) way is to look up your home on zillow.com. Another way to do it is to ask any of your friends in real estate to run a property profile search through their title company. This will get you good information. If you know any Realtors you can contact them and ask them if they would be willing to provide a broker price comparison for your house. This is probably the best information.
5. Pull together your income, asset and credit information. You’ll want to consider refinancing options if your rate is going to adjust and the best way to begin that process is to have everything together before you start talking to people. You’ll want to get your documentation together first and I’ll go in to that in a future post. In addition read this post here on the refinance process as a primer.a
A lot of people have been asking me if they are, in fact, eligible for a FHA Secure loan. The loan is designed to help people who have fallen behind on their mortgage payments as a result of a recent adjustment in the rate of their adjustable rate mortgage. Here are a few commonly asked questions about the program and what type of home owners qualify. If you are not currently late on your mortgage you are not eligible for FHA Secure; but you may be eligible for another type of FHA loan. HUD thinks that this program will help up to 250,000 home owners; are you one of them?
How many mortgage payments can I miss before I am ineligible for FHA Secure?
There is no limit to the days or number of payments you are late as long as the late payments and delinquency is a result of a reset in the rate and payment of your current adjustable rate mortgage. So you can have one late payment, or four. You can be 30 days late on your payment or 90. As long as the delinquency is a result of an ARM reset. If you are already in the foreclosure process FHA Secure may still be able to help; however, this is dependent on the lender and stage of the foreclosure process. The foreclosure process is lender-specific and as such each case is unique.
What About Before My Adjustable Rate Mortgage Reset?
You must have been current on your mortgage payments for the previous 6 months prior to your loan reset to be eligible for FHA Secure. You also must qualify under traditional FHA underwriting guidelines which typically don’t allow for more than one 30 day late payment of your current mortgage.
What if I have an Interest Only or Option ARM loan?
As long as the loan is an adjustable rate mortgage you may be eligible for FHA Secure. If the loan is a fixed rate loan you are ineligible for the FHA Secure program.
What if I have a Fixed-Rate Mortgage and am Behind on Payments?
At this time the FHA Secure program is only open to those who are behind on mortgage payments as a result of an adjustable rate mortgage resetting to an unaffordable rate and monthly mortgage payment. This may change in the future to include people trapped in high-fixed-rate subprime loans. What About the Payments I missed?
The mortgage payments missed, along with any associated servicing fees may be included in the new FHA Secure mortgage; permitted there is enough equity in the property to qualify under FHA guidelines. This minimum equity requirement is 3%.
What if My Loan is Bigger than FHA Limits?
Unfortunately if your loan is above the FHA limit for your region you will not be eligible for this product. In California that maximum FHA loan amount is $362,760. It may be increased in the future by President Bush - but there are no guarantees. If your lender is willing to take a smaller second mortgage behind the FHA Secure first you may be able to refinance a large portion of your loan in to an FHA Secure first mortgage and maintain a smaller second mortgage (up to whatever dollar amount you qualify for and your lender approves) to make up for the difference in loan amounts. Talk to your lender first.
What are some of the features of an FHA Secure Loan?
FHA Secure loans have the following features:
No prepayment penalties
No low initial teaser rates
Full documentation of ability to repay the mortgage
Require mortgage insurance paid by the borrower
Require taxes and insurance to be paid via an impound account
To learn more about this new program visit the FHASecure FAQ page set up by the Federal Housing Administration.
What if I am Not Sure if I qualify?
If you are unsure if you qualify talk to a FHA-approved lender about your options under FHASecure. You can email or call me as my company is an approved FHA lender licensed to handle all FHA loans, including the FHA Secure program.
Several people have asked me to comment on the differences between mortgage brokers and mortgage bankers and levy an opinion on which I believe to be the better business model. I am, of course, weighing in on what I believe the best model to deliver service and a solid loan to a consumer, and will ignore owner-related issues such as profit margins as they do not relate to the overall customer experience. This is not meant to be a deep introspection of the two models; rather, consider it a survey of some of the important differences between the two and their implications on customers interacting with each.
If you’re wondering why I may be able to speak to this argument with any rigor it is due to the fact that the company I own has operated under both the mortgage broker and mortgage banker business models. As the champion of our switch from brokering to banking, and the change agent involved in the transition, I have a first hand knowledge of all aspects of the differences between the two models. With this understanding I believe I can candidly discuss the pros and cons of both models; and what the implications of each are for the customer.
For those of you with limited time or attention, I’ll share my conclusion with you here. With anything complicated the answer is “it depends,” and here is the distillation of the below: if you are unconcerned about loan-product selection and you are a very vanilla-type borrower then I would suggest choosing the mortgage banker. If you are concerned about a wide selection or you have a difficult financial or credit history I would suggest choosing the mortgage broker. With one caveat, I would always suggest the mortgage broker over the small mortgage bank.
The Broker Argument The broker argument is often surmised as follows. The broker has a wide range of bank partners and loan options, making it easy for brokers to find and place the best loan for a customer in terms of price, rate and terms of the loan. The argument continues, not incidentally, that people with difficult-to-document situations can be served by this wide network of lending partners. Brokers will also excitedly share with you the discount you receive by receiving “wholesale” rates that are below the market that banks offer. The reasoning is that because the broker is responsible for overhead they receive a reduced rate from the bank – which they are graciously passing on to you, the customer.
An Argument against Brokers Often, you’ll hear someone who works for a bank or a mortgage banker tell you that working with a mortgage broker is bad news with the following pitch. A broker is an independent third party, with zero decision-making ability; they don’t approve your loan and have to wait in line with all other mortgage brokers while they wait for a decision from the underwriting department. Further, when you have a middleman you pay for that extra party involved. They have expenses that they need to cover by fees charged up front on a loan; which means higher upfront charges to you.
The Banker Argument The banker argument sounds a bit like this. By working with a direct lender you have eliminated and expensive middleman who has zero decision-making ability. You have decided to come straight to the source; and because we lend our own money we are able to make underwriting decisions, gain special exceptions, and process your loan much faster at a much lower cost to you. Everything is done in-house, there is no waiting inline, no false promises – I can give you a fully underwritten approval from right down the hall. A mortgage broker can’t really tell you what you’re approved for until they hear back from the bank, which can be weeks. Why put yourself through that when I can tell you right now whether you’re approved or not? And remember, we are a financial institution, a direct lender, not just a fly-by-night broker who you are not sure is going to be there tomorrow.
An Argument against Bankers Often, when a broker is competing against a banker they’ll use some derivative of the following argument. Mortgage bankers are exceptionally limited in the products that they are able to offer. They make their money by producing volume in limited product categories; in addition they don’t have the opportunity to shop for the true best deal for you. You only get to choose from what they offer, and depending on their specialty, those rates and programs could be far from the market value. You also don’t see how much money they truly make on your loan. They could be making thousands of dollars in additional hidden profit by giving you a higher interest rate than you deserve. Further, many small mortgage banks are nothing more than brokers on steroids. Since they sell your loan immediately they don’t always have ultimate control like they say they do. Finally, your loan will be sold immediately. This means that you may be confused about whom to make your payment to, and will have to deal with the headaches of your lender changing almost as soon as the ink dries on your loan documents.
Common Misconceptions about Brokers With anything confusing people attempt to simplify the story to make it easier to understand. We are far better at remembering and making sense out of stories than we are at remembering and processing lists of facts and figures. That’s why people tell stories and don’t rattle off bulleted lists. The problem with the way we process information and remember stories however; is that we tend to over-simplify to make the story cleaner and easier to tell and remember. For most things the result is negligible, and the simplification suits us well; for others this tendency can be damaging. Such is the case in a complex comparison between brokers and bankers. By distilling to simple comparisons we fall victims to the lack of focus on key distinctions and facts.
Here are some common misconceptions about brokers, and a humble rebuttal.
Brokers don’t have to be licensed This is patently wrong (mostly, depending on the state). Brokers are governed by state licensing institutions and therefore require licenses to operate. Federally chartered banks are not subject to state licensing requirements and therefore do not need to have their employees licensed under the state regulations in the jurisdictions where they operate. The efficacy of licensing is a debate for another time; but suffice to say, according to (most) state laws brokers of residential home loans need a license.
Brokers have no decision making power This is wrong as well. While this myth is most likely perpetuated from the past, brokers have many of the same tools as the mortgage banks in terms of underwriting and qualifying a borrower for a home loan, on the spot. Brokers have access to the same Automated Underwriting Systems (AUS) that most mortgage bankers do. This allows brokers to obtain instant approvals in-house with out needing to ship the file off to the bank for approval. Once an AUS approve is obtained, the bank simply verifies the documentation supports the information uploaded in to the AUS; they do not re-underwrite the loan, and they do not review the decision (except as noted).
This means that an approval from a broker is as solid as the one from the bank. In fact, the mortgage bank is going to do the exact same thing. Where this myth holds is in the offices of the “old school” brokers who refuse to run files through AUS prior to submitting files to the bank. By avoiding this recent technological advance the broker is putting you in line with others; and then truly has no decision making ability. Some times, if you are a subprime borrower or have a unique lending circumstance, brokers may not be able to issue an AUS approval, and then your file will need a complete underwrite at the bank your loan is destined.
Brokers are financially unstable Bankers love to portray all mortgage brokers as fly-by-night operations that don’t have the capitalization or the stability to be a direct lender. This is certainly true in some cases. Some people who obtain a brokers license choose to practice their craft on a part-time basis, others are truly the fly-by-night variety, in the industry for a quick buck and then gone the moment things get tough; however, there are some brokers that are well established, have a longer track record of success than a mortgage banker, are better capitalized and have made a choice to stay a broker.
Brokers are a rip-off There seems to be an American quality that drives us to “eliminate the middle man,” perhaps it’s been the successful marketing over the years of direct-to-consumer efforts of other industries. We love Costco, we love discount “wholesalers” we loathe paying markups and dealing with middlemen. In the case of mortgage brokers some are certainly rip-offs. The fact remains however that anyone issuing credit to you in the form of a home loan can rip you off. Bankers can certainly charge excessive fees with the best of under-handed brokers. Loan officers at banks and loan officers in a brokerage all have varying moral compasses and the institution they work for has little to do with their current direction.
Here are some common misconceptions about mortgage bankers; again with a rebuttal:
Bankers charge more on loans – you just don’t know it Some brokers argue that because mortgage bankers are not required by law (like brokers are) to disclose the compensation paid to them for selling premium interest rates, bankers are able to dupe the customer in to a higher interest rate to reap additional hidden profit. While it is true that bankers do not need to disclose that hidden profit (known as yield spread premium, see link for in-depth explanation) most are unable to maximize that hidden profit because to do so would price them out of the competitive interest rate market. Hidden profit cannot be made unless there are higher interest rates charged to the customer. Unless the customer is blindly accepting the rate on good faith, they should be able to quickly surmise that the rate offered is way out of line with even a superficial comparison shopping effort.
This competitive environment often limits this ability to hide profit from customers from turning in to a “rip off.”
Bankers are limited to only one of two programs I’ve heard the silly argument that bankers are bad for consumers because they only offer say, product A or B, and if product A or B isn’t ideal for the customer the mortgage banker still steers them in to one regardless better options “out there.” While bankers do customarily have fewer bank relationships than brokers, this does not necessarily mean they are more limited in the mortgage products they can offer. Take for instance a mortgage banker that sells to Countrywide. This banker may have in excess of 150 different loan products running the full spectrum of financing options.
Additionally, mortgage bankers may be allowed (based on the business rules established in the institution) to take loans that don’t “fit” their banking guidelines through the broker channel and act in a limited broker capacity; that is they can farm your loan out if it doesn’t fit internal guidelines. As I said, their ability to do that is really dependent upon the institution they work for.
Bankers have better rates Some people mistakenly believe that bankers have lower rates than brokers. It probably stems from the “eliminate the middleman” pitch that we discussed above. This myth is just that, a myth. Rates are based upon the rate available to the bank for the particular loan program PLUS the markup charged by the banker to cover their expenses and add to the bottom line. This markup is hidden from you, the borrower, and often from the employees – definitely the sales team. Brokers must disclose all rate markups. This doesn’t imply that banker rates are higher than broker rates, but it does suggest that regardless of business model their will be fluctuations based on decisions made at each individual business.
Some pros and cons of working with a broker
Pros
Low overhead can lead to lower rates
Wide range of products from diverse lending sources
Can source many different financing options
Must disclose all compensation associated with loan
Cons
Necessary middleman
Sometimes limited decision making ability
Can be ephemeral, lower barrier to entry for business owners
Some pros and cons of working with a mortgage banker
Pros
On-site decision making ability, more control over the process
Better rates for larger banks (volume discounting)
Cons
Don’t disclose yield spread premium profit
May charge additional fees to support overhead (underwriting, etc.)
May not have true decision making ability
Why I don’t like small mortgage banks I said earlier that if you had to choose between a broker and a small mortgage banker to always go with the broker. Here’s why I believe that.
Decision Making Ability To make a decision on a loan you need an underwriter to sign off on the loan and a funder to coordinate the funding by ensuring the final documents are in place that make the loan “sellable.” When those two positions are properly performing their job functions you have in-house decision making ability on loan approval and funding. The problem with small mortgage banks is that they may not have underwriting and funding in-house. This takes the decision making ability right back out of the hands of the small mortgage bank; making them no better than a mortgage broker on steroids.
Small mortgage banks may not have underwriting and funding in-house due to the high expense associated with the positions. Underwriters are not cheap, and while funders are relatively inexpensive it is a fixed cost that some smaller operations choose to not incur. So if you are working with a small mortgage bank they may have a contract underwriter or a part-time underwriter or use an underwriting service to approve the loans they plan on writing. This invalidates their argument of having centrally-based decision making ability because they are sending their loan files off to another source outside of their organization for someone else to underwrite and make the decision. This is exactly what brokers do.
To exacerbate that problem, smaller mortgage banks often require prior approval from either their warehouse line or end investor (the bank ultimately buying the loan) or both. This means that not only does the small mortgage bank have to underwrite the loan (by sending it out?) but they also need to receive approval from their warehouse credit facility to lend the money and they may even need the investor’s prior approval to buy the loan before they are willing or able to fund the loan.
So hopefully you can see the added complexity that can bog down your loan when you use a small mortgage bank. Instead of one approval, they may need up to 3 approvals before your loan is truly approved and ready to go. Most of these problems are alleviated when you use a larger mortgage banker who has in-house, delegated underwriting authority. The question to ask when someone tells you they are a direct lender is “Do you have in-house underwriting?” and “Do you have delegated approval authority from your investor?” If the answers are yes to both of these questions then you are in pretty good shape; if not the service provider is going through extra hoops to approve your loan for funding.
Costs As I mentioned above underwriters and funders are not cheap, and they are fixed costs for a mortgage bank; costs that aren’t there for mortgage brokers. There are other costs for mortgage bankers that are not associated with brokers – warehouse interest fees, document preparation fees, fees associated with the loan sale and transfer, and of course the added salaries of the people involved in the process.
These costs need to be recouped by small mortgage banks, and they often do it either by adding hidden profit in to the loans in the form of inflated interest rates, or by charging additional fees on the closing statement to recoup the costs of mortgage banking business. For a smaller mortgage bank that doesn’t do a lot of volume the need to recoup costs may be much higher on a per loan basis than a larger mortgage bank. Again these costs are non-existent for a mortgage broker.
You can see that a large mortgage banker, who operates on volume and therefore only needs to recoup a small portion of expenses on each funded loan; and a mortgage broker who doesn’t have the associated costs with their business model, may be less expensive than the smaller mortgage bank.
Higher Interest Rates Continuing with the above, the need to recoup costs while profiting in a higher-overhead environment can often times manifest itself in interest rate mark ups. That is, the mortgage banker is not required to disclose yield spread premium profit on each loan. They therefore are able to mark up the rates offered to them by investors in secret, before delivering them to the sales staff so that there is a fixed profit margin on each interest rate quoted. This is often profit for the house and not known by the sales staff. In order to achieve this profit though there needs to be a spread between the interest rate offered by the investor and the interest rate charged to the customer by the mortgage banker. This can be anywhere from a few percentage points to a quarter or half-again higher interest rate.
This is exacerbated in smaller institutions because of the pressure to increase margins on each unit funded because of the overhead expense associated with banking. Larger institutions can make smaller profit on each individual unit; relying on volume to make up the difference.
In Conclusion The banker/broker argument is a bit overblown. It is often used as a sales tool and the benefits of each are usually espoused the strongest based on the seller's current business model. Bankers push banking and brokers push brokering. As both a banker and a broker (a small banker, btw) I think that both models are efficient and have pros and cons that offset one another and are often overblown. I think that consumers, real estate professionals and other interacting with the lending community should not base their decisions on the business model chosen by the financing source (broker or banker) but rather on the individual merits of the people and institution. Regardless of model, I would look for people that tell the full story and look out for the best interests of the borrower as tantamount to any of the concerns above. Bankers and brokers both can be excellent sources of financing and lousy sources of financing. It’s up to the borrower to and business partner to choose their financing source based on service, honesty, integrity and follow through; more so than rate, cost or business model.
So, we’ve been hooked on the screen cast thing around here lately. First it was the podcasts, then the 30-second news clips (starring yours truly as a talking head) and now we’re on to the screen casts. In this video I cover some of the rudimentary top-level actions that got us in to this mortgage and credit mess. Not deep economic theory, not really anything deep - just a cursory look at the problems articulated by yours truly.
While this clip is geared for the Realtors out there, consumers will surely find the overview of the problem valuable.
One note of disclosure. This presentation is not mine, not the words, not the slides. You see, lots of mortgage people pay for prepackaged information that comes to them at different intervals. There are many services that provide this type of information. We get to use it as our own as part of advisor-based marketing. Lots of people use it, most don’t say that they didn’t come up with it. Personally, I find most of it disingenuous and therefore don’t use it. It’s usually too salesy. However, I thought this piece was worthy of passing on, but not worthy of passing off as my own.
In this edition of the Blownmortgage.com interview series we speak with Meg Burns, the founder of OfferAngel.com. Offer Angel's mission is to bring transparency to the loan origination process by providing loan officers with an independent platform to present their offers to consumers. It equips consumers with tools that make comparing competing mortgage offers a much easier process.
In this interview we talk about the common problems that loan originators face when working with a customer who has come from an online lead provider. We also talk about the problems consumers face when shopping for a mortgage, including a discussion on too-good-to-be-true offers and bait-and-switch tactics.
OfferAngel.com is working hard to eliminate those dangers associated with shopping for a mortgage; and make it a more equitable and honest process for both loan originators and customers.
Blown Mortgage is an affiliate of OfferAngel.com and does receive compensation if a loan officer signs up for the service through our banner links. However, we are strong supporters of anyone looking to improve the mortgage origination process by making transparency and honesty the pillars of the process.
Home equity lines of credit (HELOCs) have lately been maligned with unsustainable mortgage equity withdrawal (MEW) financing such essentials as two-week long vacations, German-imported vehicles, requisite granite counter tops and travertine flooring; however, HELOCs are a useful and important financial vehicle available to home owners. Their importance escalates in times of tightening credit and stable/declining home values. In this three part series we examine some of the important features that home equity lines of credit offer to homeowners as part of a strategic home financing plan. We’ll examine the following three features in this series:
Convertible HELOCs
True no-cost HELOCs
Equity protection & repositioning
Today, we’ll look at the important role that convertible home equity lines of credit can play in helping reduce monthly mortgage payments as well as protect against the payment shock so often associated with adjustable rate mortgages. If you are a luxury property owner or a Realtor who services the luxury market-be sure to read to the end for my Two Gems of Convertible HELOCs that are just for you.
Home Equity Lines of Credit BASICS
Before we get in to the important features we need to first cover some basic ground for those that are not entirely familiar with home equity lines of credit. A HELOC is a loan secured by your home that differs from a traditional home loan in the following ways:
It is tied to the prime interest rate, which means the interest rate can fluctuate up and down as the prime rate changes. Prime is tied to the Fed Funds rate; which dictate the short-term interest rates available on debt such as HELOCs, credit cards, and other short-term debt.
HELOCs are made up of two parts, the “line amount” which is the amount of money that you can borrow on the HELOC; and the “draw amount” which is the amount of money you initially borrow when you open the HELOC.
You can withdraw money for a set period of time after opening the line (usually 10-15 years) at any point via a credit card or checks tied to your HELOC up to the approved line amount.
You only pay interest on the amount borrowed, regardless of the line amount. With a traditional mortgage you begin paying interest on the entire amount right away.
Your minimum monthly payments are initially calculated as interest only for the first ten years. This allows you to either pay down the line, or simply make the interest payments to keep the line in good standing.
HELOCs are usually based on a 25 year repayment term. The first 10 years are interest only, the remaining 15 years principal and interest are owed to pay off the line.
May be convertible to a fixed rate mortgage one or more times during the life of the loan term. A small fee may be charged to convert.
Home equity lines of credit are often used as an alternative to a second mortgage. In the industry we refer to them 2nd liens or being in “2nd position” to refer to their subordinate position to the primary “1st” mortgage. However, HELOCs can also be used in first position, as an alternative to first mortgage products.
Convertible Home Equity Lines of Credit
A convertible HELOC refers to a home equity line of credit product that can be converted from an adjustable rate HELOC in to a fixed-rate mortgage. While each bank offers a slightly different type of convertible product most have similar characteristics.
Can convert from HELOC tied to the ever-adjusting prime interest rate to a fixed-rate mortgage (typically 30-year fixed).
Can continue to use remaining credit available above and beyond the fixed amount.
Done over the phone with a customer service representative, the conversion goes in to effect immediately.
No additional qualifying is required. No underwriting, credit review or asset/income documentation needed.
A small fee (~$250) may or may not be charged for the conversion.
Multiple conversions may be allowed. Common conversion allowances are 1, 2, and 5 times.
Conversion is to the prevailing fixed interest rate available through the bank (or some rate based on the prevailing rate + a premium for conversion).
Questions to Ask Before Committing to a Convertible HELOC
Is there a charge for converting to a fixed-rate mortgage? What is that cost?
Is there an ability to continue to use the remaining credit available on the line after a conversion?
Is the conversion to a 30-year fixed term?
Is the payment on the converted line interest only or principle and interest?
How many times can I convert?
How often can I convert?
Some Typical Uses of Convertible HELOCs
Scenario 1
People use a convertible HELOC to complete a very specific project that may take time to accomplish. Consider a lengthy home improvement project. By taking a 2nd mortgage, you receive all the money from the financing immediately and begin paying interest on that amount from day one. This is not the most desirable outcome for a large-scale renovation or remodel. If you undertake a significant addition to your home you need time to go through the planning, permitting and specification phase of the project before building actually commences. This process often takes many months.
If you are planning on financing this upfront work with money from your home equity using a second mortgage would require you to pay interest on the full amount borrowed. With a HELOC you can draw little amounts at a time to pay for related expenses. Interest is only owed on the money borrowed.
In these types of situations a HELOC may save you money over the long run, as you are only charged interest on the money you borrow. However, once the project is complete and you anticipate no future withdrawals on your HELOC; converting to a fixed-rate allows you to keep your monthly payments fixed for the duration of the repayment period. This removes your exposure to jumps in the prime interest rate, and the concomitant increases in monthly payments.
Scenario 2
People also convert their HELOCs in to a fixed-rate loan once they’ve used the balance of their home equity line. Similar to the end state of scenario 1, once the HELOC is tapped out it makes sense to protect yourself from the exposure of rising interest rates. Converting the HELOC to a fixed-rate loan accomplishes that nicely.
Scenario 3
If interest rates begin to rise quickly and you have no current need for your equity line, converting to a fixed-rate loan can create dramatic monthly savings when compared to letting the interest rate float. This strategy makes sense usually under the following conditions:
You have multiple conversions available on your line.
You are able to continue to use the line after converting the currently-owed balance to a fixed-rate
If your line has these options, then converting the currently-owed balance to a fixed rate can provide you with stable monthly payments, while still maintaining access to your equity for future expenses.
Using the Convertible HELOC as a First Mortgage
Here is where convertible HELOCs get interesting; especially in a higher-rate environment like the one we are currently facing in the housing market. Let’s take the specific example of a home owner who maintains a property worth $1,000,000; a common scenario along the California coast. If they purchased the home within the last five years, or have refinanced in the last five years, they more-than-likely hold some type of jumbo, Alt-A 1st mortgage (or 1st and 2nd combo). Jumbo mortgages are anything over $417,000, the conforming limits for Fannie Mae and Freddie Mac purchase. Alt-A mortgages had low rates and loose qualifying guidelines during the past five years, making it easy for people owning expensive properties to find inexpensive financing. The mortgage market has changed dramatically in the last few months.
The current mortgage market for jumbo and Alt-A loans has been priced with a much higher premium to interest rate lately as the secondary mortgage market has balked at high-balance home loans. A jumbo loan in 2005 that was 6% is now 8% - a huge increase when considering the large loan amounts associated with high-end properties. On a million-dollar loan this change represents a 23% increase to the monthly payment. This has effectively locked high-end property owners out of the refinance or purchase markets.
It is especially painful to jumbo loan holders who are also in adjustable rate mortgages (ARMs) coming in to their adjustment period. Many Alt-A loans were mid-term ARMs with 3, 5 and 7 year terms. These loans face pricey payment adjustment schedules which can make a once affordable mortgage quickly unaffordable.
Here is where our friend the convertible HELOC comes in to play. Home owners facing the specter of an ARM reset in a jumbo loan can use the convertible HELOC in two ways to help reduce their mortgage payments. I call these the Two Gems of Convertible HELOCs.
Gem 1
Take the HELOC in first position as a 1st mortgage. Some convertible HELOCs convert to a much lower interest rate than their 1st mortgage jumbo competitors. Ask your mortgage professional what the going rate is on the converted loan and you may be surprised to find that it is nearly a full point lower than the going jumbo interest rate on the same loan. Continuing our $1,000,000 loan example from above; this 1% interest rate difference results in a 9% monthly payment savings. This savings can be the difference between affordable mortgage option and unaffordable mortgage option.
The reason this exists is that some HELOCs convert to the going 30-year fixed rate, regardless of other factors. Now this type of program is not available at every bank, if you can find a bank that does-you now have a viable jumbo loan alternative to the pricey 1st mortgage products available today.
This does carry some caveats. You must understand the conversion options, the rate that you’d be converting to, and any other limitations prior to signing on for the HELOC. Some banks make their conversions overly expensive to keep this type of financing from cannibalizing their jumbo loan financing pipeline. You also need to understand that you may have to carry the higher interest rate of the HELOC for a period of up to a week after signing loan documents. This requires that you have a very trusting relationship with the mortgage professional you work with; and that you verify all aspects of the HELOC documents carefully to ensure your conversion options match what you discussed during the loan process.
Gem 2
Instead of taking the whole loan balance as a 1st position HELOC, take a conforming 1st mortgage up to $417,000 and then take the remaining as a convertible HELOC. Once you sign the loan documents you can convert the HELOC to a fixed rate and achieve a blended interest rate (the effective interest rate of your 1st and 2nd mortgage combined) that can also be up to a point lower than the going jumbo loan rate.
In order to calculate the blended rate of the two mortgages use the following equations:
(1st Mortgage / Total Mortgage Amount) x 1st mortgage interest rate = Rate 1
(2nd Mortgage / Total Mortgage Amount) x 2nd mortgage interest rate = Rate 2
Rate 1 + Rate 2 = Blended Rate
An example:
1st Mortgage: $417,000
2nd Mortgage: $583,000
1st Mortgage rate: 6.5%
2nd Mortgage rate (after conversion): 8.5%
(417,000 / 1,000,000) x 6.5 = 2.71%
(583,000 / 1,000,000) x 8.5 = 4.96%
Blended rate: 7.67%
Conclusion
The convertible HELOC is an important financial tool for any homeowner; especially homeowners who are in jumbo loan products. As detailed in the example above a convertible HELOC can provide an avenue of lower-cost financing than the current Alt-A and jumbo loan markets currently offer. There are some definite caveats so it is important that you speak with a mortgage professional who can expertly match your current financing needs with the best combination of products available on the market today.
Contact my team to learn more about how jumbo loan financing can still be affordable using a convertible home equity line of credit.
In part 1 of this series on credit we talked about how important credit has become in surviving the current home depreciation environment and avoiding the ARM Reset Foreclosure Trap. In part 2 of the credit series we looked at the elements that comprise your credit score. Part 3 covered improving your score on your own and outlined the importance of credit management and protecting your credit report. In part 4 examined the pros and cons of using and outside credit repair service. Our conclusion was that it probably made sense to try to fix credit errors yourself. In the conclusion of the series we look at the best ways to manage your score and ensure you’ll keep your score heading up, up, up! Here is a recap of the series so far and where we are at to date:
Over the past four articles we’ve examined credit and how your actions can improve or damage it. We’ve given you some tools to repair and improve it. Today we will give you some tips for maintaining your score and improving it. The main goal of this series is to help people with short-term adjustable rate mortgages improve their credit enough to enable them to refinance in to a better loan when the first rate adjustment date arrives. This is the best chance you have to avoid the ARM Reset Foreclosure Trap if you are planning on staying in your home.
You can’t control the value of your home, you can’t control the interest rate your loan will reset to when the fixed period ends, you can’t (assumably) pay down your mortgage balance significantly; the one thing you can do is improve your credit. You do this by managing your score.
Manage Your Score
Managing and improving your score is kind of like exercise. The more you use it, condition it, and look after it the better and stronger it becomes. If you go to the gym, eat well, keep track of your weight, caloric intake and improvements at the gym you become healthier and stronger. Same goes for credit.
Track Your Score
It is important to keep track of your score, its changes and performance and whether it is increasing or decreasing. The best way that I have found to monitor your score is through myFICO.com’s Score Watch program. This program monitors your Equifax credit score daily and your FICO score weekly. It does the work for you. For about the cost of 2 cups of Starbucks a month you’ll be alerted to any changes to your credit report and score. This is a valuable service that anyone who wishes to invest in protecting and improving their credit score should use.
I’ve stated through out this series that my wife and I both used the Score Watch program while improving our credit and it helped me add well over 100 points in the last year through proper management and payment history. Please note again that I am an affiliate of myFICO.com and do get compensated for sales through my site. However, I have been promoting myFICO.com for over 3 years now and have only recently in the last two months become and affiliate. It is a great service.
The nice part about this service is that if anything derogatory appears on your credit you can research and dispute it right away to have it removed. You can also take a proactive approach to managing your scores. If you see your scores decline you can look at your report and determine what may be negatively impacting your score.
Proactive Management
Just like anything else of great import in life; it is better to be proactive about your credit score than reactive. The worst feeling in the world is applying for credit and not knowing if you’ll be approved or not. Not knowing your score puts you at a disadvantage. It gives people power to tell you what you do and don’t qualify for. It puts you at the mercy of people who would try to take advantage of you by your ignorance in this arena. Know your score. It is as important as your social security number, and more important than your drivers license number.
Watch for any changes in your score, positive or negative
Maintain a close eye on your credit card balances - keep your balances ideally under 33% of your credit limit and definitely under 50%
Always make your mortgage payment - missing a mortgage payment can be the single most devastating thing you can do to negatively impact your credit score
Sign up for automatic payments on all revolving accounts - this simple move is guaranteed to improve your score; especially if you have a tendency to be lazy with bill payments
Promptly follow up with all disputed items - work quickly to remove erroneous items from your credit report and payment history
Get everything in writing - it is extremely important that you keep a written record of any and all disputes you have regarding your report and payment records on your credit report. Keeping written documentation will help you whenever another party or opinion is needed to settle a credit matter.
If your score is going down
If your score is dropping it is important to obtain a copy of your credit report and ascertain why the score is declining. Remember your score can be impacted negatively by any of the following:
Too many inquiries on your credit report
Balances on revolving accounts of more than 50% of your credit limit
Reporting of a late payment on your mortgage or other reporting accounts
Too much debt, for example another car, second home or other large debt item
Public judgment, tax lien, unpaid parking tickets, etc.
When you review your report take a look at what may be dragging your score down and work to rectify it quickly. Here are some common ways to rectify a score drop:
If your score is hit by excess debt it may be because an old mortgage or automobile account is still showing as active even if you’ve already refinanced that old mortgage, or turned in a leased vehicle or sold your old car. While you no longer have that debt the bureau may count it against you if the account is not properly recorded as closed.
If you’ve been shopping excessively for items that require a credit inquiry your score will take a temporary hit. Take a break from running your credit for about 3 to 6 months to allow your score to recuperate. Too many inquiries make you look desperate for credit - which hurts your score. Time will clean this up.
If your balances are getting large it may make sense to open another card and transfer some of the debt to the new card. This may be effective if you only have one or two cards with high balances. Having a third may allow you to return your debt levels to under 50% of the credit limits. This takes discipline however; do not use the new card to rack up additional debt.
Essential Reminders
Do not miss a mortgage payment, please. This is one of the worst things you can do. There was a study recently that showed Americans are more likely to make their credit card payment than their mortgage payment. If you are in a short-term adjustable ARM and are planning on refinancing in the next 12-18 months this is a terrible decision.
Know what is on your report. I’ve seen loan applications declined because borrowers didn’t know that their gym membership was reporting on their credit and they neglected to pay their gym dues. I’ve seen a late library book from a University library shave 30 points of a credit score. Don’t let trivial items hurt your chances at getting a great loan.
Fight erroneous information. No one is going to clean up your credit report for you with out you being vigilant about keeping it clean and pristine. Dispute errors quickly and in writing to document your efforts. Your credit is your responsibility.
Avoiding the ARM Reset Foreclosure Trap
If you refinanced to a high loan-to-value (85% or higher) loan over the last two years; and chose a short-term adjustable rate mortgage in the process - these articles are for you. Regardless if your loan expires in 6, 12, or 18 months it is important to begin working on your credit now. The reason is simple. The combination of falling home prices, rising interest rates and tighter underwriting guidelines will make high loan-to-value loans available only to those with the best credit. If you are not in that group you will have to deal with the consequences of an ARM Reset and payment adjustment which can be financially devastating.
Work now to avoid that trap.
First time homebuyers
This advice applies to you as well. By managing your score before you begin the home buying process you will ensure yourself access to the best rates and loan programs on the market. The more programs you have to choose from the more manageable owning your first home becomes.
Conclusion
Credit is essential. Access to credit is a major determinant to your success and quality of life; especially in regards to your home. Please understand that recent events in the mortgage market make it essential-now more than ever-to improve your score to protect yourself from deleterious changes. I hope that you are able to use some of these concepts and skills to raise your score. Using these same skills I personally raised my score over 100 points in two years and 200 points in a little over 3 to put me in the best position possible for my financing needs. You can do it too.
In part 1 of this series on credit we talked about how important credit has become in surviving the current home depreciation environment and avoiding the ARM Reset Foreclosure Trap. In part 2 of the credit series we looked at the elements that comprise your credit score. Part 3 covered improving your score on your own and outlined the importance of credit management and protecting your credit report. In this part of the series we’ll look at options for improving your credit using third party services. Here is a recap of the series so far and where we are at to date:
A note before we begin. Before you agree to work with any third party to improve your credit score you need to do the following things:
Know and understand your current score, and understand the items on your credit report. You can do this by signing up for MyFICO, an inexpensive, accurate way to keep tabs on the accuracy of your credit report.
Know and understand what is legal and what is illegal when it comes to credit repair.
Carefully examine the fees charged and the results guaranteed by the party you choose.
How to Avoid Scams
Just like in mortgage, if it’s too good to be true, it probably is. Ignore any company that makes any of the following claims:
We can erase your bad credit - guaranteed!
We can remove bankruptcies and judgments permanently!
Get new credit instantly!
Form a personal corporation and get all the credit you need, now!
These all represent untrue statements about credit repair. You are setting yourself up for disappointment if you do business with these types of firms.
By law, credit repair organizations must give you a copy of the “Consumer Credit File Rights Under State and Federal Law” before you sign a contract. They also must give you a written contract that spells out your rights and obligations. Read these documents before you sign anything. The law contains specific protections for you. For example, a credit repair company cannot:
make false claims about their services
charge you until they have completed the promised services
perform any services until they have your signature on a written contract and have completed a three-day waiting period. During this time, you can cancel the contract without paying any fees
Your contract must specify:
the payment terms for services, including their total cost
a detailed description of the services to be performed
how long it will take to achieve the results
any guarantees they offer
the company’s name and business address
I have heard horror stories of people sending thousands of dollars to “credit repair” companies only to find their situation unimproved and their precious cash squandered on false hope. Do not let this happen to you. As with all financial situations do not rush in to a decision; and always get a referral if possible.
Types of Third Party Credit Repair Companies
Consumer Credit Counseling - These companies take all of your outstanding debt, analyze the creditors, balances and interest rates compared to your monthly income. They then negotiate with all of your creditors to reduce your overall debt and monthly payments. While this sounds good; it really looks bad on a credit report. This is a red flag to an underwriter reviewing your credit history. Some banks will consider this almost as negatively as a bankruptcy. While it may be beneficial to consult with a credit counselor to help game plan a way out of your debt; it can be very costly to your future credit options should you engage them to restructure your outstanding debt.
If you choose to work with a credit counselor simply use them to help remove disputed items that appear on your report. They can provide you templates and contacts to help you remove incorrect information on your report.
Consumer Law Offices - Lawyers like to tout that they are more effective than credit counseling companies because, well, they are lawyers. The truth is that they take the same steps as everyone else to remove disputed items. There is nothing inherently bad about using a law firm to remove credit items that are erroneous; its just that they don’t have different avenues than other organizations that may be less expensive.
Individual Credit Counselors - There are many independent “credit experts” who offer services to repair or improve your credit score. They may be former employees of the above types of firms or not. As long as you use the same precautions in researching and selecting them as the above companies they can be a reasonable alternative to the above.
The Best Alternative?
Most people turn to third party companies when they are desperate and in need of help. This is the wrong time to begin to work on your credit profile. The best bet may be to do it yourself. Using a copy of your credit report and some template correspondence you can effectively clean up your credit report with out having to pay the fees associated with the above services. The bottom line is that, all things considered, being your own credit counselor may be your best bet.
If you’d like samples of the template letters you can use to dispute items on your credit report please email me at morganb@blownmortgage.com and I’ll be happy to send them to you. if you’d like a detailed white paper on how your credit score impacts your home financing options please email me as well. Much of this information is based on the FTC’s Consumer web site on Credit Repair - you can learn more by visiting the FTC site.
In part 1 of this series on credit we talked about how important credit has become in surviving the current home depreciation environment and avoiding the ARM Reset Foreclosure Trap. In part 2 of the credit series we looked at the elements that comprise your credit score. Hopefully now you have a good understanding of why your credit score is so important and how it is calculated. Here is a recap of the series so far and where we are at to date:
As I said in my last post you are going to use the understanding of the elements of your credit score to help you improve your score organically. When I say organically I mean “by yourself.” In this post we are going to talk about some of the most powerful ways to improve your credit score on your own. So let’s get started.
Setting a Baseline
Before you can work on improving your score you need a baseline; you need to know where you are at so that you can set some realistic targets for improvement. “If you don’t know where you need to go, any road will get you there” - someone famous. This is true with your credit score as well. You won’t know which of the following tactics to use or not use unless you understand your credit file and the items in it. In order to establish your credit score baseline you need a copy of your credit report.
Getting a Copy of Your Credit Report
There are thousands of services that offer “free” credit reports just for joining their service. As in mortgages - anything that is too good to be true probably is. These sites really don’t offer free reports, and in fact many of them have been subject to lawsuits over their deceptive advertising tactics. The government passed legislation that mandates that each of the three main credit bureaus Equifax, TransUnion and Experian, provide you with free copies of your report once a year. That sounds like the route to go; unfortunately the bureaus are not compelled to (and don’t) provide you with your credit score - only the raw data of the report. While this can be helpful it doesn’t allow us to set the baseline we need.
To get your scores I recommend using MyFICO.com. MyFICO.com is run by the Fair Issac Company which developed the basis for the scoring model FICO. FICO is the score that is given to you based on the information in your credit profile (as discussed in the Elements of Credit article). MyFICO.com offers many services that allow you to view your credit as often as you like with out any penalties. They have very reasonable subscription programs. I highly recommend getting a subscription to their service. For around $3/month you can have access to the information that can save or cost you hundreds each month in mortgage and other loan payments.
I must disclose at this point that (1) I use MyFICO.com and have had exceptional results (which I’ll discuss in more detail below) and (2) that I receive affiliate commission if you choose to sign up for MyFICO.com through this site. This should not taint my advice. If you’ve been reading Blown Mortgage for some time now you’ll no doubt remember in very old posts (before I was a MyFICO affiliate) that I recommended MyFICO to Blown Mortgage readers. In fact I’ve only been an affiliate for about a month but have been recommending them for over 3 years now to clients and friends.
Once you subscribe to MyFICO.com you’ll have access to your reports and scores. Now this is where the fun begins. We are going to look at the best ways that you can improve your scores with out the assistance of credit repair or other type credit services.
Understanding Your Score
First, look at your credit score. What is it? In today’s lending market (which is getting tougher every day) here are the ranges of credit in the order of best to most marginal and the lending category you typically qualify under:
850-720 - Prime (excellent credit)
719 - 620 - Alt-A (good credit)
620 - 540 - Subprime (fair credit)
500 & below - Hard Money (poor credit)
Depending on where you are on this credit ladder will dictate the goals you set for yourself and your score improvement. Let’s set a goal to move you up one credit grade. This is not an easy task but ultimately what we are trying to do is get you to a point where you can avoid the ARM Reset Foreclosure Trap and that will require excellent credit. “Every journey begins with a single step.” - another famous person.
The Information in Your Report
One of the first things to do is to go through your report line-by-line and review all of the accounts listed. Consider this: In June 2004, The U.S. Public Interest Research Group published the results of a survey it conducted involving 200 adults in 30 states to test the validity of credit reporting. Their findings were as follows:
Twenty-five percent (25%) of the credit reports contained errors serious enough to result in the denial of credit;
Seventy-nine percent (79%) of the credit reports contained mistakes of some kind;
Fifty-four percent (54%) of the credit reports contained personal demographic information that was misspelled, long-outdated, belonged to a stranger, or was otherwise incorrect;
Thirty percent (30%) of the credit reports contained credit accounts that had been closed by the consumer but incorrectly remained listed as open.
Those numbers should be startling to you; and they should remove any doubt in your mind as to why you would want to review your credit. Credit plays a large factor in your quality of life by determining how much you pay for money. Why would you let erroneous information cost you money? You shouldn’t.
Correcting Errors
As you comb through your report look for errors and incorrect or outdated information. Verify all sections including :
Accounts - are they updated correctly and marked as either closed, paid off or open?
Public records - are there judgments, liens, bankruptcies or other actions that shouldn’t be on there?
AKA’s - is someone else’s name on your credit report (especially common if you have a common last name)
Inquiries - are their inquiries from companies you don’t recognize (could be an early indicator of credit fraud)
Employment - is there an employer listed that you are unfamiliar with? (could be an indicator of mixed up information in the rest of your report)
If you find errors in your reports here are some simple steps to help fix them. Fixing erroneous information is the number 1 fastest way to improving your credit score.
Make a copy of the report and circle the items you are questioning. Keep your original copy for your own records.
Prepare a letter to the bureau that provided you with the report in question, and request to have the erroneous item(s) removed. If you have proof of payment for an item in question, include a copy of that documentation.
Prepare a letter to the creditor reporting the problem, especially if you feel you are a victim of fraud or identity theft. Inform the creditor that you are disputing an error reported to the bureau, state why the claim is inaccurate, and include any relevant documentation to prove your point.
You can find the addresses for each of the bureaus at the end of your credit report. You can also dispute much of the information online as well; but for record keeping it may make more sense to do it via regular mail. You should keep a file for any items that you dispute.
If you’d like some sample letters requesting updates, changes and fixes to your credit report please email me at morganb@blownmortgage.com. I will be happy to send these templates to you.
When my wife and I first signed up for MyFICO.com and pulled copies of our reports we couldn’t believe the errors that were on our report. It was truly amazing. Over the next 6 months (and yes it can take that long, and longer) we systematically cleared each piece of erroneous information. There were credit cards that weren’t ours, information from people with similar names (my last name Brown is extremely common) and more. By correcting those errors our scores each went up approximately 50 points. It was amazing. While you may not have the same success you will more than likely get a bump in your score if there is incorrect information on your report that is impacting you in a negative way.
Account Balances
Another easy way to add points to your score is to keep your account balances low. We talked in a previous post about the utilization rate of your credit. The lower that is (except when it’s zero) the better your score will be. However, the magical numbers seem to be 50% and 33%. If your account balances are below 50% of the total line of credit your score will improve than if they are over that mark. Further if you are able to reduce them down below 33% of the available credit you may receive another bump to your score.
The simple solution here is to pay down balances so that you get accounts below the magical 50% utilization line. Going from 52% to 49% can earn you a good chunk of points on your score. Even shifting debt around to a different card to reduce one high-balance card can earn you points even if you aren’t improving your overall debt picture.
Leveraging Seasoned Accounts
One of the biggest mistakes that people make that cost them points is closing charge cards and other accounts that they have had for a long time that are in good standing. The urge to pay it off and cut up the card is strong; but its a head-fake. The longevity of your accounts factors in to your score. The more seasoned your accounts are the more weight they receive. If they are in good standing the more they act positively towards your score. Closing a long-held account is a bad idea and can cost you points.
The solution: keep accounts in good standing open - don’t close them out!
Time
Time heals all wounds is just as true in relationships as it is in credit. Each month that goes by where you make payments on time and meet credit obligations means a few more points to your score. These are important. There are magical breaks (listed above) on the credit ladder that those few points can mean the difference in qualifying for a loan or not. Run together enough positive months and you will amass points while improving your score. Some estimates suggest that by making your mortgage payment and other debt payments on time for a period of 2 years you can increase your score 40 - 70 points. In the scheme of things 24 months is not that much time.
Authorized Co-Signer Accounts
These accounts have recently come under fire and Fair Issac (FICO) has started eliminating these from their score calculations. The premise is that you are added to an account of a spouse or family member who has excellent credit (like a credit card). That account shows up on your report and improves your credit score based on the good payment history on the account. This has been a common practice between parents and children for years; however, just recently changes have been made to discount those accounts.
Solution: Don’t count on authorized signer accounts to improve your credit!
Utilizing Credit
Another common mistake made is that people with previous credit problems shy away from using credit for fear of abusing it again or losing control of the charges and payments. Unfortunately by not using credit you are not working on improving your score. If you have damaged credit you should attempt to qualify for a low-limit card (say $350) or apply for a secured credit card. A secured credit card is one where you credit availability is backed by the amount of money posted to an account that secures that credit. You can usually open one of these with as little as $500. By utilizing your credit and showing your ability to use credit in a responsible manner you’ll increase your score. If you don’t use your credit there will be no track record of good payment history to improve on your credit scores.
Solution: Use credit wisely and actively. Make small purchases such as gasoline and groceries and repay a substantial part of the bill off each month.
Final Thoughts
Improving your credit score organically really comes down to managing your credit wisely over time. That is why it is so important to get started today. If you are in an adjustable rate mortgage that will recast in 9 months start today. Same advice applies if you have 5 months or 3 years left before you will need to consider refinancing. The more time you give yourself the better results you’ll be able to achieve through responsible credit management.
Erroneous information can be costing you thousands of dollars. Sign up for MyFICO.com and review your information. Dispute inaccurate items and watch your credit improve as faulty data gets cleaned up. Remember you have to drive that process. The bureaus are slow to react and slow to make updates. Get started now on cleaning up any wrong data.
Utilizing the above advice can gain you anywhere from 30 to 100 points or more in credit score improvements. I hope that you are able to clean up your credit and improve your history and profile to climb the credit ladder up to the excellent rung; it gives you the best chance of avoiding the ARM Reset Foreclosure Trap.
For a copy of my free white paper on your credit score please email me at morganb@blownmortgage.com. I’m happy to send it along. If you’d like the template letters to send to the credit bureaus you can email me there as well.
In part 1 of this series on credit we talked about how important credit has become in surviving the current home depreciation environment and avoiding the ARM Reset Foreclosure Trap. Now that you know (hopefully) how important credit is to protecting yourself and family from foreclosure it’s time to look at the elements of credit to understand the factors that affect your score. You’ll use this understanding to your advantage in parts three and four as you work to improve your credit score both organically and through 3rd parties.
You might expect payment history to account for more; but in fact it only contributes to 35% of your credit score. It is however the most significant contributor out all the elements that are used in your score calculation. Late payments, charge-offs and judgments are all factors that have a negative impact. Missing high-balance payments have a larger impact than missing low-balance payments. Further, if you miss a mortgage payment you hurt your credit in two very critical ways:
You incur a late payment on your highest-balance credit account causing the greatest harm to your score.
You drop a credit grade on loan underwriting matrices limiting your loan options and increasing your interest rates.
Finally, most weight is given to your payment performance over the last two years. Older delinquencies are still a factor but are weighted less. If you maintain a clean payment history on your credit accounts for at least 24 months you stand a much better chance at getting lower interest rate, higher LTV loans. Which is exactly what you need access to when trying to avoid the ARM Reset Foreclosure Trap.
Current Credit Balances - 30% of Score
Credit balances are used to calculate the ratio of your credit used compared to the total amount of credit available to you for revolving credit accounts. To calculate this number simply take the total amount of money spent on an existing credit card and divide it by the card limit, then multiply that number by 100. This is your credit utilization percentage for that particular card. For example:
Credit Limit on VISA: $15,000 Current Balance: $10,000
In the above example you have used 67% of the credit available to you, leaving you little remaining credit. This will negatively impact your credit score. While the ideal utilization percentage is somewhat debatable depending on who you talk to; most experts agree that utilization percentages below 50% (and definitely below 30%) favorably impact your score. In fact simply reducing your outstanding credit on any particular account from 51% to 49% has shown to provide significant score improvement.
Credit History - 15% of score
Credit history refers to the length of time that each credit account is open. An account in good standing that has been open for 5 years carry much more weight on your score than an account in good standing open for 4 months. The track record of your payment history is weighted to present a truer picture of your repayment habits.
Type of Credit - 10% of score
Credit bureaus frown on large amounts of debt from any one segment of financing. Too much credit card debt will impact your score; too many auto loans can have the same effect. The credit score is meant to paint a picture of responsible credit use. If you carry 10 credit cards with high balances your score will be impacted; even if you make all of your payments on time. That is because the excess debt burden makes you a higher risk for potential delinquent payments.
Inquiries - 10% of score
The dreaded credit inquiry. Yes, they really do impact your score. The total number of inquiries is evaluated over a 6 month period. The first 10 inquiries can impact your score - anywhere from 2 to 25 points per inquiry! This is a massive range. It is no wonder why your gut says that credit inquiries are a bad thing. Credit inquiries are factored in to your score because credit bureaus want to penalize people who are desperate for credit. If you are applying for, and being denied, credit all over town that process is going to take its toll on your credit score.
There are two common misconceptions about credit inquiries that you should be aware of:
All inquiries on my credit report are bad. FALSE. If you make an inquiry in to your own credit history it is not seen as a negative. In fact, you should personally check your credit every 6 months; and at least once a year to ensure its accuracy.
Too many inquiries on my credit report are bad. FALSE. Too many inquiries over a long period of time are bad. Credit repositories allow a 14-day shopping window for consumers shopping for products that require a credit check. In this 14-day window you can have multiple inquiries in to your credit history with out a negative impact on your score. With out this type of grace period no one would be able to shop competitors for financed items such as home loans, car loans, and financed home furnishings, appliances and electronics. The damage is done when you repeatedly seek credit on an ongoing basis.
It is important to remember that the credit bureaus use an algorithm to determine your credit score; and they all have slightly different formulas which is why your score differs from each of the three major bureaus. In the next segment I’ll talk about strategies to improve your credit score organically with out the help of outside parties. You’ll be able to use your knowledge of the scoring model covered today to effectively manage your credit use to improve your score.
Remember, we’re trying to achieve the best credit score possible before we are forced to refinance. A high credit score gives us our best chance at leveraging high loan-to-value mortgage products to get us out of adjusting ARM loans - avoiding the ARM Reset Foreclosure Trap.
If you’d like a free white paper on the elements of credit and how they impact your borrowing power please email me at mbrown@newdaytrust.com.
Disclaimer: ActiveRain Corp. does not necessarily endorse the real estate agents, loan officers and brokers listed on this site. These real estate profiles, blogs and blog entries are provided here as a courtesy to our visitors to help them make an informed decision when buying or selling a house. ActiveRain Corp. takes no responsibility for the content in these profiles, that are written by the members of this community.
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