Prior to the years running up to 2000, credit reports were viewed manually. That is to say the underwriter, the individual working for the mortgage company that makes sure a loan meets the guidelines for any particular loan program, would review each credit item line by line. What information was reviewed? The first thing looked at is the payment history. Credit reports both then and now report any payments made more than 30, 60 and 90 days past the due date. Payments made after the due date but before 30 days are not counted. The credit line will also list any collection accounts. An account goes into collection when the creditor gives up on trying to get someone current on an account.
When a payment is noted past 30 days, it will list how many such payments were reported and the date the late payment was made. An isolated late payment or two over the past couple of years really wouldn’t raise any eyebrows. Several such payments would. If a payment is seen as more than 60 days late, it would require a written explanation from the borrower and faced more scrutiny. An account in collection would cause the application to be declined.
Underwriters also look at account balances and credit limits. Lenders want to see borrowers utilize credit, after all how would a lender be able to document a stable credit history, but lenders don’t want to see too much credit being used. Ideally, a credit account should have a balance somewhere near one-third of credit limit. If a credit card had a $10,000 limit, then an ideal balance would be $3,000. This combined with timely monthly payments would pass the credit test.
Enter Credit Scores
Electronic credit scoring had been around for several years but for mortgage loan approvals they didn’t really take hold until the late 1990s. Soon thereafter, the FICO Company developed an algorithm that all mortgage companies now follow that produces a three digit number representing a credit history. These scores range from 300 to 850 and review the very same items that a manual approval used. That being payment history and account balances. Scores also look at the various types of credit used, how long someone has used credit and any recent requests for credit made by the consumer.
A payment history makes up the bulk of the credit score representing 35% of the total score. When someone makes payments on time, this information is delivered to the three main credit repositories of TransUnion, Equifax and Experian. In fact, merchants and businesses that issue credit report all payment activities of their customers beyond just payment history. Available Credit compares balances with credit lines and takes up 30% of the total score. If account balances are near one-third of credit lines then scores will improve. As account balances approach the credit limit, scores will begin to falter and when a balance, even temporarily, reaches above the credit limit, scores will fall much faster.
When someone is experiencing some form of financial distress and begins using credit cards more than usual and late payments start to show up, that will cause scores to plummet. Yet on the other hand, if scores are low and the financial situation improves scores can just as quickly rise back to acceptable levels.
There are three loan programs available today that are considered government-backed. These loans are VA, FHA and USDA loans. All three carry a guarantee to the lender that compensates the lender to some degree should the loan ever go into default. With the VA loan, the guarantee is 25% of the loss. This guarantee isn’t funded by the government but funded by the borrower with the VA’s Funding Fee. This fee is 2.15% of the loan amount and rolled into the new mortgage for first time buyers.
But it’s important to understand that the VA does not approve loans. The VA used to but over time gradually handed over the approval process to VA approved lenders who have the authority to underwrite a VA loan application and approve the appraisal as well. The VA just issues the guidelines lenders must follow in order for the loan to receive the guaranteed status.
VA Loans and Credit Scores
The Department of Veteran’s Affairs charges VA approved lenders to verify the applicant has a “responsible” credit history. This doesn’t mean a perfect credit history but it does mean responsible one. Occasional late payments spread out over the past couple of years typically aren’t an issue and the credit score will reflect this aspect. Yet the VA doesn’t require a specific credit score. Other loan programs may require a minimum credit score but the VA leaves this up to the individual lender. Individual lenders have the authority to set their own minimum credit scores for VA loans.
We mentioned there are three credit repositories and they each use the same algorithm. When these scores are returned to the lender, there will then be three such scores. They won’t be exactly the same, or they rarely are, but they will be similar. This is due to various dates and times different businesses report credit date to the three bureaus and not all businesses subscribe to all credit services. For example, three scores might be reported as 690, 689 and 710. Which one does the lender use? Some believe that lenders average the three scores together but instead what lenders do is to throw out the lowest and the highest score and use the middle one. What if there are two or more on the same application? In this instance, the lender uses the lowest middle score reported.
For instance, a husband and wife apply for a VA loan and the two middle scores are 724 and 700. The lender would then use 700, the lowest middle score, when processing the loan application.
But while the VA doesn’t require a minimum credit score but lenders do. The most common minimum credit score is 620 but that isn’t always a requirement. A lender may ask for a minimum credit score on a VA loan to be 620 but if the score is below that, say at 605 for instance, the lender can still approve the loan based upon other positive aspects of the loan file and an explanation from the borrowers regarding the event(s) contributing to the lower score. These other positive aspects are referred to by lenders as “compensating factors.” A compensating factor might be an extended employment history, notable cash reserves such as a checking or savings account or a retirement fund.
Credit scores that lenders use aren’t available to consumers. FICO scores are designed for mortgage applications and while there are various websites that provide credit scores either for free or a nominal fee, they’re not the same. Credit card companies typically offer a credit monitoring service and can provide a credit score upon a customer’s request. By doing so, a borrower might obtain a score from the credit card company at 610 but the lender’s FICO score comes in at 660.
For those who think their credit may not be ready for a VA loan, it’s important to let a loan officer decide that for you. There are other important aspects in a credit file other than credit so don’t make the mistake of not applying because you think you have bad credit. What you may think is bad credit may not be bad at all. If you’re VA eligible, it’s time to talk to an experienced loan officer.
The Author, Matt Herbolich, MBA, JD, LLM NMLS #1649154 is the Editor-In-Chief of Loan Consultants. He is a senior loan officer at USA Mortgage, a division of DAS Acquisition Company, LLC NMLS# 227262. Mr. Herbolich is also the Co Editor-In-Chief of The Gustan Cho Mortgage & Real Estate Resource Center at www.gustancho.com . Contact Matt Herbolich for your Real Estate and Mortgage Questions. USA Mortgage is a direct lender with no lender overlays on Government and Conventional Loans. Mr. Herbolich can be reached 7 days a week at 888-900-1020 by phone, on his cell at 786-390-9499 by either phone or text, or by email firstname.lastname@example.org.