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Credit & credit repair explained

 Creditworthiness of Borrowers  

Generally, with any lender, the degree of financial risk involved is the overriding concern when considering whether to approve a loan. To weight that risk, lenders consider two primary factors:

  1. The borrower's ability and willingness to repay the mortgage debt, and 
  2. The appraised market value of the mortgaged property. Giving full consideration to both factors helps ensure the borrower is a good credit risk.

To further minimize the lender's financial risk, the loan is also secured by the home as collateral. Among the primary criteria lenders use to evaluate a borrower's creditworthiness are:

INCOME                                                                                                                      Income from salary or other sources must be stable and verifiable, have a history or track record and be likely to continue in the future. Applicants with frequent or recent job changes must provide sufficient, justifiable explanations. Income derived from sources other than employment generally takes extra time and effort for the lender to confirm. Frequently, the lender may request that federal income tax returns from previous years or a business's financial statement and balance sheet be submitted.



The applicant's willingness to repay the loan in a timely manner is a vital consideration in approving a loan. A satisfactory record of mortgage payments on previously owned real estate or rental payments is important.

To review the applicant's full credit history, lenders obtain a standard factual data credit report from the Credit Bureau. Late payments, past-due accounts, collections, judgments and bankruptcies reflect irresponsibility toward repaying debt and must be explained fully by the borrower. Other alternative credit sources may be researched if a credit history report isn't available.


To qualify for the loan, the borrower also must demonstrate a consistent pattern of accumulating assets. Assets may be applied toward a down payment, which lowers the lender's risk, or retained as a cushion for unexpected future expenses, which also minimizes the lender's risk.

At the very minimum, the borrower must have sufficient assets to pay for the cash down payment, any prepaid items and the closing costs of the loan. However, lenders also want the borrower to have liquid assets remaining in an amount equal to at least two month's mortgage payments after settlement.

Conventional loans require a minimum 5% down payment. Private mortgage insurance (PMI) is usually required on down payments of less than 20%. PMI protects the lender against financial loss in case the borrower defaults. Borrowers who have smaller down payments may be able to get assistance through the FHA or VA loan programs.


In assessing the degree of financial risk, lenders also consider the borrower's installment debt, revolving charge account balances, amount of child support, alimony or maintenance payments, and any checking account credit lines.


When deciding whether to grant a loan, lenders also consider the property's appraised market value. Lenders use a Loan-to-Value (LTV) to calculate how much mortgage money the lender is willing to lend. Basically, the LTV is the relationship--expressed as a percentage--between the mortgage amount and the lesser of the appraised value of the property or the sales price. The higher the LTV the more financial risk to the lender, while a lower LTV generally means less risk and more latitude in approving the loan application.


Credit Score 

When determining the investment quality of a loan, lenders assign the loan with the equivalent of a grade, A paper being the highest quality loan, and D paper being the highest risk to the investor.

To help determine if a loan is an A paper or not, the federal National Mortgage Association (Fannie Mae) and the federal Home Loan Mortgage Corporation (Freddie Mac) have established guidelines to determine the investment quality of the loan. These guidelines help lenders to make their decisions and also enable the investors that buy the securities that are backed by these mortgages to know how much risk they are taking.

An investment quality loan can be defined as a loan made to a borrower from which timely repayment can be expected and that the loan is secured by sufficient collateral in case of default. A lender uses the guidelines provided by Fannie Mae and Freddie Mac to determine if a loan is of investment quality. If the loan falls outside the guidelines, it can be considered a B, C, or D paper loan, depending upon how far outside the established guidelines a particular loan falls. A lender who is making a B, C or D paper loan is taking a higher risk since there is an increased likelihood of the loan defaulting. The lender is compensated for higher risk by charging the borrower a higher interest rate. It is important to remember that the loan decision process can be subjective and the guidelines are just that, guidelines, not rules etched in stone. Therefore, different lenders may rate the same loan differently when determining the investment quality of a loan. That is where your mortgage broker comes in as he or she knows which lender can give the highest grade to your loan.

Also, some lenders use a credit scoring system to determine the credit risk. There are three main credit-scoring systems, namely Equifax's Beacon and TRW's FICO and Transunion's Empirica, which predicts the likelihood that an existing account or potential credit customer will become a serious credit risk. Beacon has a minimum credit score of 400 with a maximum of 844. FICO score ranges from mid 300's to high 800's. Empirica is similar to FICO and Beacon. The higher the credit score, the better the credit risk. Generally speaking, a credit score of 680 plus should put one in 'A' paper category. It must however be noted that not all lenders give the same value to a particular credit score. Besides, not all lenders use credit scoring system and even when they do they may not use it for all their loan programs. Once again, your mortgage broker is your best guide as he or she should know right away as to which lender will not only accept your credit score but will also be able to offer you the best rate in your situation.


Two main factors determine what Credit Grade you are. They are:

2. Debt Ratio

The interest rate a lender will charge depends on these two factors. If both the factors are great, the loan is assigned 'A" grade and therefore qualifies for the best interest rate. If even one of the factors is not up to par, the quality of the loan is downgraded to 'A-" or 'B' paper. Consequently, the interest rate goes up as the perceived risk factor increases.

'A' Paper: In plain English, A Paper refers to borrowers with excellent credit which means no late charges whatsoever for the last 7 years. Debt ratios of no more than 28/38. As usual, marginal exceptions are possible with strong compensating factors.

'B' Paper allows borrower three 30 day mortgage late charges;. Three 30 day and one 90 day installment or revolving accounts late charges during the last 24 months. Back end debt ratio to be no more than 48%. Any Bankruptcy dismissal or discharge should be over 3 years ago with reestablished credit. These are general guidelines and may vary from lender to lender. Exceptions are always possible with strong compensating factors. Besides 'A' and 'B', the mortgage industry also have 'A'-, 'B'+, 'C' and 'D' paper, too. D papers refer to what is known as hard money loans, which are mostly based on the equity in your home and not on your credit. Back end ratio could be as high as 65% but Loan to Value ratio drops to less than 65%.

Loan-to-Value Ratio (LTV) refers to the loan amount as percentage of the market value of the house. A $100,000 loan on a $200,000 house will be at 50% LTV. The higher the LTV, the more stringent the lenders become on credit and income. Under 65% LTV, most any loan can fly even if one has Credit and Debt Ratio problems. Even now, if one is an 'A' paper, one can get 100% LTV loan and in some cases even 125%.

Debt Ratio (DR) stands for income-to-debt ratio. Traditionally, the debt ratio has been somewhat like 28/36. 28 is called the front ratio and 36 the back ratio. They are also known as top and bottom ratios. The 28% refers to your monthly housing expense (PITI) as a percentage of your gross monthly income and 36% represents your PITI plus total of your all other recurring monthly payments on personal loans, credit cards, auto loans etc. However, lately these ratios have been stretched. FHA accepts as much as 29/41. Conventional 'A' paper loans are being done at as much as 36/42 and even more. 'D' papers loans, of-course, go up to 65% back ratio.

Besides, Credit and Debt Ratio, other factors are your discretionary income, job stability and the most important your real property also has to qualify.

FICO Score - a Brief Explanation

When you apply for a mortgage loan, you expect your lender to pull a credit report and look at whether youve made your payments on time. What you may not expect is that they seem to be more interested in your "FICO" score.

"Whats a FICO score?" is a common reaction.

Each time your credit report is pulled, it is run through a computer program with a built-in scorecard. Points are awarded or deducted based on certain items such as how long you have had credit cards, whether you make your payments on time, if your credit balances are near maximum, and assorted other variables. When the credit report prints in your lenders office, the total score is displayed. Your score can be anywhere between the high 300s and the low 800s.

Lenders wanted to determine if there was any relationship between these credit scores and whether borrowers made their payments on time, so they did a study. The study showed that borrowers with scores above 680 almost always made their payments on time. Borrowers with scores below 600 seemed fairly certain to develop problems.

As a result, credit scoring became a more important factor in approving mortgage loans. Credit scores also made it easier to develop artificial intelligence computer programs that could make a "yes" decision for loans that should obviously be approved. Nowadays, a computer and not a person may have actually approved your mortgage.

In short, lower credit scores require a more thorough review than higher scores. Often, mortgage lenders will not even consider a score below 600.

Some of the things that affect your FICO score are:

o        Delinquencies

o        Too many accounts opened within the last twelve months

o        Short credit history

o        Balances on revolving credit are near the maximum limits

o        Public records, such as tax liens, judgments, or bankruptcies

o        No recent credit card balances

o        Too many recent credit inquiries

o        Too few revolving accounts

o        Too many revolving accounts

FICO actually stands for Fair Isaac and Company, which is the company used by the Experian (formerly TRW) credit bureau to calculate credit scores. Trans-Union and Equifax are two other credit bureaus who also provide credit scores.

FICO Scores and Your Mortgage

Four years ago, credit scoring had little to do with mortgage lending. When reviewing the credit worthiness of a borrower, an underwriter would make a subjective decision based on past payment history.

Then things changed.

Lenders studied the relationship between credit scores and mortgage delinquencies. There was a definite relationship. Almost half of those borrowers with FICO scores below 550 became ninety days delinquent at least once during their mortgage. On the other hand, only two out of every 10,000 borrowers with FICO scores above eight hundred became delinquent.

So lenders began to take a closer look at FICO scores and this is what they found out.   The chart below shows the likelihood of a ninety-day delinquency for specific FICO scores.

FICO Score


Odds of a delinquent account






























































If you were lending thousands of dollars, whom would you want to lend it to?

FICO Scores, What Affects Them, How Lenders Look At Them

Imagine a busy lending office and a loan officer has just ordered a credit report. He hears the whir of the laser printer and he knows the pages of the credit report are going to start spitting out in just a second. There is a moment of tension in the air. He watches the pages stack up in the collection tray, but he waits to pick them up until all of the pages are finished printing. He waits because FICO scores are located at the end of the report. Previously, he would have probably picked them up as they came off. A FICO above 700 will evoke a smile, then a grin, perhaps a shout and a "victory" style arm pump in the air. A score below 600 will definitely result in a frown, a furrowed brow, and concern.

FICO stands for Fair Isaac & Company, and credit scores are reported by each of the three major credit bureaus: TRW (Experian), Equifax, and Trans-Union. The score does not come up exactly the same on each bureau because each bureau places a slightly different emphasis on different items. Scores range from 365 to 840.

Some of the things that affect your FICO scores:

  • Delinquencies
  • Too many accounts opened within the last twelve months
  • Short credit history
  • Balances on revolving credit are near the maximum limits
  • Public records, such as tax liens, judgments, or bankruptcies
  • No recent credit card balances
  • Too many recent credit inquiries
  • Too few revolving accounts
  • Too many revolving accounts

Sounds confusing, doesnt it?

The credit score is actually calculated using a "scorecard" where you receive points for certain things. Creditors and lenders who view your credit report do not get to see the scorecard, so they do not know exactly how your score was calculated. They just see the final scores.

Basic guidelines on how to view the FICO scores vary a little from lender to lender. Usually, a score above 680 will require a very basic review of the entire loan package. Scores between 640 and 680 require more thorough underwriting. Once a score gets below 640, an underwriter will look at a loan application with a more cautious approach. Many lenders will not even consider a loan with a FICO score below 600, some as high as 620.

FICO Scores and Interest Rates

Credit scores can affect more than whether your loan gets approved or not. They can also affect how much you pay for your loan, too. Some lenders establish a "base price" and will reduce the points on a loan if the credit score is above a certain level. For example, one major national lender reduces the cost of a loan by a quarter point if the FICO score is greater than 725. If it is between 700 and 724, they will reduce the cost by one-eighth of a point. A point is equal to one percent of the loan amount.

There are other lenders who do it in reverse. They establish their base price, but instead of reducing the cost for good FICO scores, they "add on" costs for lower FICO scores. The results from either method would work out to be approximately the same interest rate. It is just that the second way "looks" better when you are quoting interest rates on a rate sheet or in an advertisement.

FICO Scores and Mortgage Underwriting Decisions

FICO Scores as Guidelines

FICO scores are only "guidelines" and factors other than FICO scores affect underwriting decisions. Some examples of compensating factors that will make an underwriter more lenient toward lower FICO scores can be a larger down payment, low debt-to-income ratios, an excellent history of saving money, and others. There also may be a reasonable explanation for items on the credit history which negatively impact your credit score.


They Don't Always Make Sense

Even so, sometimes credit scores do not seem to make any sense at all. One borrower with a completely flawless credit history had a FICO score below 600. One borrower with a foreclosure on her credit report had a FICO above 780.

Portfolio & Sub-Prime Lenders

Finally, there are a few "portfolio" lenders who do not even look at credit scoring, at least on their portfolio loans. A portfolio lender is usually a savings & loan institution who originates some adjustable rate mortgages that they intend to keep in their own portfolio instead of selling them in the secondary mortgage market. They may look at home loans differently. Some concentrate on the value of the home. Some may concentrate more on the savings history of the borrower. There are also "sub-prime" lenders, or "B & C paper" lenders, who will provide a home loan, but at a higher interest rate and cost.

Running Credit Reports

One thing to remember when you are shopping for a home loan is that you should not let numerous mortgage lenders run credit reports on you. Wait until you have a reasonable expectation that they are the lender you are going to use to obtain your home loan. Not only will you have to explain any credit inquiries in the last ninety days, but numerous inquiries will lower your FICO score by a small amount. This may not matter if your FICO is 780, but it would matter to you if it were 642.

Don't Buy A Car Just Before Looking for a Home!

In conclusion, a word of advice not directly related to FICO scores. When people begin to think about the possibility of buying a home, they often think about buying other big-ticket items, such as cars. Quite often when someone asks a lender to prequalify them for a home loan there is a brand new car payment on the credit report. Often, they would have qualified in their anticipated price range except that the new car payment has raised their debt-to-income ratio, lowering their maximum purchase price. Sometimes they have bought the car so recently that the new loan doesnt even show up on the credit report yet, but with six to eight credit inquiries from car dealers and automobile finance companies it is kind of obvious. Almost every time you sit down in a car dealership, it generates two inquiries into your credit.

Credit History is Important

Nowadays, credit scores are important if you want to get the best interest rate available. Protect your FICO score. Do not open new revolving accounts needlessly. Do not fill out credit applications needlessly. Do not keep your credit cards nearly maxed out. Make sure you do use your credit occasionally.  Always make sure every creditor has their payment in their office no later than 29 days past due.

And never ever be more than thirty days late on your mortgage.  Ever.


Cleaning up Your Credit

Mortgage lenders generally check with three credit bureaus in order to evaluate youre past payment history. Your goal in cleaning up your credit report should be to clean up each of the three bureaus. If you only work on one, this does not effect the reporting to the other bureaus.

Get A Copy of Your Credit Report

The first step is to get a copy of your merged credit report, which shows all three of the major bureaus, Experian (formerly TRW), Equifax (formerly CBI), and Trans-Union.  Most mortgage lenders will obtain data from all three of these bureaus in analyzing your credit history.  The exception is that some portfolio lenders (usually adjustable rate lenders) may only review one. 

What to Say When You Call Your Creditors

There are two efforts that must be made. First, call any creditors reporting a negative and ask them to remove the negative item. Ask in a nice calm voice and do not get upset when they say no. Simply repeat your request over and over in your nice pleasant voice. If you get nowhere, then ask to speak to the supervisor. Make sure you keep a log of your conversation, noting the date, time, who you spoke to and what they said. Repeat this procedure over and over. In a high percentage of cases, it works.

Get Written Confirmation of Agreements

Be sure to ask for a letter by mail or fax that shows the creditor is correcting the negative information. You may need this letter for two reasons. First, they may not actually make the changes. With the letter, you can appeal directly to the credit bureau and they will make the correction. Second, if you are applying for a mortgage before the changes actually hit the credit bureaus report, your lender will need this documentation.

If you have a charge off or collection account that shows as unpaid, dont just send them a check and pay it off. Call the creditor on the phone, explain that you have the funds to pay the account in full, and calmly explain why it should not have been reported on your credit in the first place. Then ask if they will provide you a letter deleting the account entirely from all credit bureaus if you pay off the account. Try to get them to fax it to you. As before, be sure to document all of your telephone contact and always keep a nice pleasant tone in your voice. In a large percentage of cases, this also works.

Disputing the Report -- When Your Creditor Will Not Remove an Item

There will be cases when the creditor does not agree to remove the negative credit item. If it is an item that is definitely not yours, call the credit bureau immediately (except for Equifax, who only responds by mail). When on the telephone, do not discuss any negative items that are accurate. Do not discuss any items that may be accurate in general but have some small error in detail that you can dispute by mail. Once you confirm any accuracy at all, you cannot dispute it later by mail.

For the remaining items, you need to dispute them by mail, writing directly to the credit bureaus. Write a letter to the appropriate bureau including your name, social security number, address, disputed accounts, and account numbers. You must sign the letter. Inform the bureau that you are disputing the data as it appears on your credit report.

Mistakes on Your Credit Report

Almost every item on your credit report will have some mistake, even if only slight. Do not acknowledge any any of the accuracies, but be sure to note all inaccuracies.  Write next to each item something like, "not mine, not accurate, mistaken item, complete error," or whatever is most appropriate. Request a copy of the corrected report within thirty days. If they do not respond within 30 days, send another letter. In this letter you will include a copy of your dated original letter and a new letter firmly requesting they remove the disputed information. Include a cc: to the Federal Trade Commission.

Do Not Call the Credit Bureaus - Write Letters

The credit bureau may write a letter asking you to call. Do not call under any circumstances. Your phone call will be recorded and a log will be made of the conversation. Simply write back with copies of your original letters, telling them of the original date you submitted your request. Keep a file of all correspondence to and from the credit bureau and follow through continually. Do not get discouraged, as this will be worth your while.

What happens is that the credit bureaus forward your dispute to the individual creditors. Who have forty-five days to respond? If they do not respond within the allotted time the item must be removed. However, if they do respond at a later date with information that documents the credit report is correct, the item will be placed back on your credit report.


For those of you who have filed bankruptcy in the past, the items that were discharged will normally show up as a charge-off or uncollected debt. You will want to write to the credit bureaus, providing a copy of your complete bankruptcy papers and request that they show the debt as "discharged in bankruptcy." This looks better and raises your FICO score. FICO sores above 680 make it easier to obtain mortgage loans.


You may not be able to clean up every item on your credit report using these methods, but you will certainly be able to improve the way it looks to potential creditors.

Check your credit reports annually.   Or, if you're turned down for credit, you're entitled to free reports and the opportunity to clear up mistakes.  Here's who to call:

Equifax (800) 685-1111

Experian (888) 397-3742

TransUnion (800) 888-4213


Make a Plan and Get Pre-Qualified.

Armed with the following when applying for a loan will make the process a lot less stressful and make it seem like a breeze.

Full Names and Social Security numbers of all.

Your home address, including zip code, for the last 24 months.

If you were renting, a copy of the lease, the landlords name and address, and monthly payments

If you are military a copy of your orders. If you living in leased or base housing a letter from the housing office stating you occupied quarters

A list of all account numbers, current balances, and complete bank address for all checking, savings, and credit union accounts

Copies of your last three months checking, savings, and retirement account statements

List all retirement fund information, including serial numbers of savings bonds, stocks, and similar assets. Provide copies of Award Letters

Copies of most recent investment account statements

If you are obligated to pay alimony, child support, or separate maintenance, bring a copy of the recorded divorce decree and/or maintenance agreement

For VA or FHA/VET loans, you will need to provide your VA Certificate of Eligibility. If you have not obtained the Certificate of Eligibility it is wise to immediately apply for it now. This will save time and prevent a lot of stress

Name and complete address and phone number of employers (for all applicants) for the last 24 months

Most recent pay stubs covering one full month and Year To Date for all applicants or a copy of your last 3 pay stubs

For military members, you will need a Statement of Service from your Commander

Last two years W-2 forms for all applicants

If you are using Child Support it is always helpful if you have a statement from the Court that disburses the payments. Writing to the Court and asking for a copy of past payments made or copies of checks you received can obtain this. If this is not available, copies of youre bank statements showing regular deposits

You will also need a copy of the Decree that establishes the Child Support in the current amount. It is also wise to have a copy of the Divorce Decree

If you are unable to provide the required documentation, your lender, under the Alternate Documentation Program, will tell you what type of document can replace the required document.