Credit Scoring

What is a Credit Score?

A credit score is a number used by lenders to calculate the degree of risk in making a loan. Scores are calculated from a lot of different credit data in your credit report. This data can be grouped into five categories as outlined below. The percentages in the chart reflect how important each of the categories is in determining your score.

The credit score referred most often to is called:
Fair Isaac Company (FICO). For more information visit www.myfico.com

Their numbers range from 350 to 900, the lower the number, the greater the likelihood of default. By evaluating the historical performance of loans with certain borrower credit characteristics, future performance of loans with similar credit characteristics can be predicted.

Factors that have the most influence on lowering credit scores are called reason codes. Four reason codes are given with each credit score. Examples include:

• Too few accounts currently “paid as agreed”
• Current delinquency (late payments)
• Too many inquiries in the last twelve months
• Proportion of balances to credit limits too high on revolving accounts

Fannie Mae and Freddie Mac endorse the use of credit scores when underwriting loans. Underwriters are recommended to use the following approaches:

Fannie Mae recommends that borrowers with low credit scores should have offsetting strengths as a means of compensating for the lower score. Compensating factors are:

• Strong equity position (large down payment)
• Debt ratios below the highest standard ratios
• Excess cash left in the bank after closing
• Successful history of paying housing expenses equal to the monthly housing expense

Credit Scoring Benefits

Can speed up loan approval for those with high scoresGenerates more time to evaluate low scoresThey are objective (the scoring model does not consider items such as race, sex, religion, or national origin)May help reduce foreclosures if used correctlyThey are predictive of mortgage default