Credit Scoring -- "The Impact On Mortgage Loans"
There are major differences when comparing the process of obtaining a car loan and a home loan. Auto loans take this course. After the car is sold, the salesman escorts the customer to the financing department, located at the dealership. The finance manager has the customer complete a simple loan application which takes about an hour. After the loan is approved, the customer drives off the lot with an asset that immediately depreciates 20% or more.
The home loan process takes on a more cryptic course. Generally, the process takes 15 to 45 days and requires mounds of paper work before the loan is approved; the actual loan closing may take an additional 3-5 days. All of this paperwork is required on an asset that does not move and rarely depreciates.
The mortgage lending process outlined above is about to change. Lenders are now looking to shorten the processing time for many borrowers through the same tools used for car financing -- credit scoring.
In a nutshell, credit scoring is a statistical method of assessing the credit risk of a loan applicant. The score is a number that rates the likelihood an individual will pay back a loan. The score looks at the following items:
There are three major credit repositories that prepare credit scores. They are Equifax, Trans Union, and TRW. One of the scoring models has been created by Fair, Isaac & Co, which prepares a numerical score that ranges between 450 to 850 -- the lower the score, the higher the risk. This score is commonly known as a FICO score.
In a survey of 1 million loan records, Fair, Isaac found that one in eight borrowers with a FICO score below 600 were either severely delinquent or in default. In contrast, only one in 1300 borrowers with a scores above 800 had similar delinquency problems.
The strong evidence of predicting delinquencies has prompted major secondary market investors --FNMA and FHLMC -- to begin using FICO scores in their quality control of lenders selling loans to them. FNMA found only 10% of borrowers in loans they purchased had scores below 620, but the group accounted for 1/2 of all defaults. Both secondary market investors are highly recommending lenders use credit scoring as a method to assess default risk.
Credit scoring will place borrowers in one of three categories:
First, a borrower with a score above 650 to 675 may be considered an A+ loan. The loan will involve basic underwriting, probably through an "computerized automated underwriting" system and be completed within minutes. Borrowers falling in this category may have a good chance to obtain a lower rate of interest and close their loan within a couple of days.
Second, a score below 650 but above 620 may indicate lenders will take a closer look at the file in determining potential risks. Borrowers falling in this category may find the process and underwriting time no different than the past. Supplemental credit documentation and letters of explanation may be required by lenders before an underwriting decision is made. Loans within this FICO scoring range may allow borrowers to obtain "A" pricing, but loan closing may still take several days or weeks as it does now.
Third, borrowers with a score below 620 may find themselves locked out of the best loan rates and terms offered by lenders. Mortgage professionals may divert these borrowers to alternate funding sources other than FNMA and FHLMC. Borrowers may find the loan terms and conditions less attractive than the "A" loans, and it may take some time before a suitable funding source is located.
As more lenders utilize credit scoring, the loan approval and closing will be compressed for most consumers. In the future, a high FICO score may be your ticket to a speedy and competitively priced mortgage loan.