How to Understand Credit and Improve Your Credit Score - Part 1

Are you looking to buy or refinance a house? How is your credit? Credit has always been a big factor in qualifying for a loan, but with recent changes in the mortgage industry, the underwriting is stricter and a good credit score is now more important than ever. This is a big topic, so I'm going to break it up into several posts. I will cover how the credit system works, how banks and mortgage companies look at your credit, what goes into your FICO scores and how to fix mistakes and problems in your credit rating.

It's hard to function in America without good credit. It's not just about buying things, either. If you apply for a new job, more and more employers are running applicant's credit before hiring. Auto and home insurance rates are now tied to credit scores, too. But if you want to get a mortgage at the best terms, how well you've managed your accounts, and how you've made your payment in the past are key factors.

That doesn't mean you're out of luck if you have a few late payments on your record. Your overall credit pattern is the key, not just isolated incidents. And even if you have had serious problems in the past, there are still ways you can buy.            

Your credit record is compiled by 3 companies, Equifax, Experian and Trans Union. These companies are called credit repositories. Their business is to gather information from businesses and financial institutions throughout the country and then sell this compiled information back to them so they can use it as a basis for their credit decisions. Each repository does this independently of the others, so your credit profile and scores will differ slightly in each. If you are applying for credit at Home Depot or Best Buy, they will usually only pull from one repository. When we run a mortgage credit report we pull a tri-merged report which draws from all 3 repositories.      

Your credit report is a record of all the credit you've built up over your lifetime (This is the real permanent record your teachers warned you about back in school). Your credit report gives a list of all the accounts you currently have, as well as any accounts that you have closed. It shows the balance of each account, the credit limit on each, your payment history showing late payments as 30, 60, 90 or over 90 days past due, and any past due balance you still owe. It also shows a record of any bankruptcies, judgments, and foreclosures you may have had.  

When I first got into the mortgage business back in 1992, all this credit information was underwritten manually. That means that the underwriter would base their loan decision on how well the borrower conformed to established credit guidelines. There were guidelines, but it came down to a judgment call on the level of risk the loan carried, and some underwriter's would accept more risk than others.

Things have changed now, and more of the decision is now based more on credit scores and automated underwriting. Still, it is all about risk. In the next installment I will talk about FICO scores how they measure risk and what you can do to show yourself in the best light.

If you are even starting to think about getting a loan, the first thing you should do is get a copy of your credit report and see what it has to say. I will go over this in depth later, but there are a couple of ways to get a copy of your report. By law, each repository has to give you a free copy of your report once each year. You can get the reports at annualcreditreport.com. These reports will give you all the data of the report, but they won't give you the credit score. To get the scores you will need to pay. You can order each from the repository website, or you can get them all for a fee ay Myfico.com.  I'll have more on this in later installments.

Illustration Credit Cards by KingNapolean - Courtesey of deviant Art

Pete Thompson is an Illinois based mortgage banker who provides superior mortgage service and competitive mortgage rates in Chicago, the Chicago area and throughout Illinois. Click here for a Free copy of The Real World Home Buyer's Guide - How to Save Thousands when Buying a Home and Getting a mortgage.