Why should you check your credit score is one of those questions that people think they know the answer to but does not spur them into action.
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Why do people who ask themselves, Why should I check my credit score? do not check their credit score, or do not do it often enough?
Probably because they do not think what the worst-case scenarios are.
The worst-case scenario is that someone stole your identity. The next one is that you might not be able to purchase the house or car you want.
Why Should You Check Your Credit Report in the Mortgage Context
This being a blog about mortgages, I will answer the question as it relates to getting a loan to buy or refinance a home.
Your credit report has two components: scores and history. Each one can kill a mortgage loan application. But things are not as simple as that.
Credit scores determine if you get a loan at all. Together with LTV’s (loan-to-value ratios) they determine how much you are going to pay for your loans, that is to say, they determine the interest rate and, often, the amount of reserves you need.
Credit Score Thresholds
There are lenders that lend to anyone with a middle score of 500 (assuming they meet all the other requirements). Some want at least 580, others 600 or 620 or 640. The lower the middle score, the fewer options and the higher the interest rate, though.
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Also, if the middle score is under 640 (for some, under 620), the application goes to manual underwriting. Manually underwritten loans, for most lenders, limit the amount someone can borrow. More precisely, they insist that DTI (debt-to-income ratio) be smaller. So, yes, it is a good idea to check your credit score.
Conventional conforming loans (loans that Fannie Mae would buy) allow for DTI’s as high as 50%. FHA allows the housing DTI to be 47% and total DTI to be 56%. However, if the middle score is so low that manual underwriting kicks in, the DTI is going to be 37% for the housing debt (principal, interest, mortgage insurance premium, hazards insurance premium, property taxes, home owner’s association fees, if applicable) and 43% for all debt.
|Income: $4,000/month Other Debt: $300/month Property Taxes: $400/month Property Insurance: $100/month No HOA Interest Rate: 3.750% Loan Type: 30-Year, Fixed, FHA||Income: $4,000/month Other Debt: $300/month Property Taxes: $400/month Property Insurance: $100/month No HOA Interest Rate: 3.750% Loan Type: 30-Year, Fixed, FHA|
|Manual Underwriting||Automatic Underwriting|
|The loan amount can be just a bit higher than $253,800||The loan amount can be only a bit higher than $180,455.|
|Manual Underwriting||Automatic Underwriting|
|The mortgage debt (principal, interest, mortgage insurance, property insurance, property taxes) is $1875.70.||The mortgage debt (principal, interest, mortgage insurance, property insurance, property taxes) is $1478.16.|
The above calculation assume that the FHA’s upfront insurance premium of 1.75% of the loan amount is included into the loan. In my part of the world, $50,000 extra buys a lot.
History means significant credit events (bankruptcies, foreclosures, etc.), it also means patterns and recent lates. Some lenders just don’t have programs for people who have a bankruptcy (foreclosure, etc.) on their credit reports. Some have programs for people who had one of those events yesterday (i.e., it was recorded as closed yesterday).
Some lenders want no lates on a mortgage in the past 12 months; some can deal with 1, some with 2.
No lender I’ve come across will deal with accounts that are in dispute.
Some people, even if they have credit scores that are high, cannot qualify for a loan because of the credit history; some can qualify but at interest rates that are too high for their tastes.
Because negative histories mean higher risk to lenders and higher risk means higher interest rates.
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So, next time you Why should you check your credit score or report pops into you head, act on it. As you have seen, it actually pays in real dollars to do it before you apply for a mortgage loan. And it pays in reduced stress if you do it early, at least a couple of months before you apply for a mortgage loan.
Time and not being late fixes everything, but it can take a lot of time. Often, a more proactive approach is needed. Sometimes, as proactive as hiring a credit repair company, sometimes only as proactive as challenging one item in the report.