How Credit Reports Affect Mortgage Loans

Whenever you apply for a loan be it a car loan or a mortgage, the borrower will look at your credit score or otherwise known as the FICO score. FICO is derived from the Fair Isaac Company who developed the system of rating your credit information. It quantifies your probability of paying your debts based on a three digit number. The higher the credit score, the better your credit rating. FICO scores ranges from 300 (the lowest) to 850 (the highest).

Excellent: 750 and up

Good: 720 to 749

Fair: 660 to 719

Uncertain: 620 to 653

Poor: 619 or lower

Scores less than 620 suggest heightened risk of default. Scores under 575 are considered sub-prime. To obtain the report on your credit score, there are three major credit reporting agencies that you can go to. They are Equifax, Experian and TransUnion.

Your credit report may be bad but you may still get a mortgage loan for a home purchase, a refinance mortgage, or even a cash out mortgage refinance on your current home. Regardless whether you have charge-offs, collections or tax liens on your credit report, as long as you can meet the exact guiding principle for a loan approval by a multitude of mortgage lenders specializing in the credit-damaged borrower market.

The home mortgage loan industry uses class categories to determine the credit risk of any particular borrower. If the property checks out and you have adequate income, impeccable credit and the required down payment you are considered an 'A' borrower. An 'A' borrower can walk into almost any residential loan lender and get a mortgage loan. A mortgage borrower can fall short in one of these areas and still be considered an 'A' borrower, as long as the other areas can recompense for the weakness.

For example, a residential mortgage borrower that exceeds the required monthly debt-to-income ratios (28% housing debt and 36% combined debt) could provide a large down payment. Many mortgage companies will also wave modest credit 'blemishes' if a reasonable clarification is provided (i.e. job transition, medical problems). Being 30-60 days late on one credit card payment is a typical blemish that could be accepted by a mortgage banker.

Bad Credit Categories

What about those that have more serious marks against their credit? Depending on how imperfect your credit history has been, home loan lenders will typically put borrowers into the following credit categories, which are qualified by time frames:

A-minus credit (FICO Score 575 to 619)

Acceptable blemishes within the last two years: Charge-offs, or collection accounts, of minor amounts (e.g. less than $500 in all) are acceptable. Medical bills (e.g. hospitalization and clinic visits) tend to be disregarded by the lender. As for payment habits, the borrower can have no more than two 30 days late payments, or one 60 days late payment on revolving or installment credit.

B credit (FICO Score 575 to 619)

Acceptable blemishes within the last 18 months: Up to four 30 days late or up to two 60 late days payments are permitted on revolving and installment debt. If the credit ding is an isolated incident, a 90 days late payment is allowed within the last 12 months. Charge-offs, or collection accounts, which are isolated, insignificant, and under $1,000 in all, are acceptable. However, outstanding collection accounts less than four years old must be paid. Bankruptcy or mortgage foreclosure that had been discharged or settled previous to the 18 months time frame is allowed.

B- to C credit (FICO Score 525 to 574)

Acceptable blemishes within the last 12 months: No more than six 30 days late payments, three 60 days late payments, or two 90 days late payments are permitted on revolving or installment credit. Open collections accounts and charge-offs cannot go over $4,000 and must be paid in full. Bankruptcy or foreclosure of a mortgage that had been discharged or settled prior to the last 12 months is acceptable.

C- to D credit (FICO Score less than 525)

A sporadic disregard for timely payment or credit standing categorizes the borrower in this class. Open collections accounts, charge-offs, and judgments must be paid through loan proceeds. The borrower who had filed bankruptcy and had been discharged prior to the last six months is acceptable, as much as the ex-homeowner who had his previous home foreclosed and settled prior to the last six months. However, mortgage payments cannot be longer than 90 days past due.

The above are general industry guidelines to make lending judgment on the borrower's mortgage loan application. There are no strictly defined rules of separating the borrower on the borderline between one credit category and another. Also, there are variations between one mortgage lender to the next depending on the degree of subjectivity involved in underwriting and how much each mortgage banker wants to commit their funds.