Many homeowners ask why is my credit score lower when the bank pulled it and here is the simple answer:
The main reason why your credit score is lower is because the credit score your mortgage lender obtains is based on a different “algorithm” than the algorithm consumer credit monitoring sites use for their credit scoring models. In fact the three credit bureaus, Equifax, TransUnion and Experian each use a separate model to evaluate your credit. It can be a bit complicated to figure out but we break it down in terms you’ll understand so that you’re better informed about your credit report and what that means for your mortgage application.
What Is A Credit Score?
A credit score is a number that is generated from a calculation of your debts, payment history and negative derogatory items like liens and foreclosures as reported to the three credit bureaus. The score is based on an algorithm that is responsible for comparing all the information in your report to generate that score.
Credit Score Models:
The three main credit bureau’s are Equifax, TransUnion and Experian and each bureau has it’s own credit scoring model. Only TransUnion uses a FICO scoring model.
- Equifax uses FACTA BEACON 5.0 scoring model
- TransUnion uses FICO CLASSIC 04 scoring model
- Experian uses FAIR ISAAC MODEL II scoring model
Each model is different and how it scores a credit history can be significantly different. Sometimes there are 20 – 30 point spreads between your high credit score and your low credit score. And these models are specific to the mortgage industry; other industries (like auto) receive a different score based on the models that are specific for that group.
You could walk into a car dealership, run your credit and one minute later run your credit with a mortgage company and you would most likely get different scores. And it’s not because of the inquiry; it has to do with the fact that the algorithm the three bureau’s use for the auto industry is a bit different than the algorithm for the mortgage industry.
The Two Most Well Known Credit Score Models:
The two most well known credit score models are FICO and Vantage. A version of FICO is used in the TransUnion scoring model, in the Equifax and Experian model but Vantage score is not (this is specific to the mortgage industry).
FICO stands for Fair Isaac Corporation and was the first major scoring model. Other less well known scoring models include Credit Xpert Credit Score and CE Credit Score.
The FICO Score model is weighted heavily towards your Payment History and Credit Utilization (how credit you use) as the main two factors when determining your credit score. Other factors include Credit Use and Credit Inquiries.
The Vantage Score model came out in 2006, just before the “Great Recession” it’s the brain child of the three major credit bureaus. Under the Vantage Score model payment history is the number one factor, then the age and type of credit is the second main factor in determining someone’s Vantage Score. The third main factor is how you use your credit cards (are they max’d out?) and the last three are as follows:
- Total Balances
- Recent Behavior
- Available Credit
As mentioned the Vantage Score is not used when a Loan Originator pulls your credit report but many consumer sites and credit card companies provide a Vantage Score to consumers.
Where Does The Term “Pull Your Credit” Come From:
Years ago, before a company could obtain your credit report online, a company had to obtain your credit report in writing from the bureau’s directly (via regular mail and eventually fax). The bureau’s had to “pull” up your report and mail it to the company (or fax it) that was requesting the report.
You would think that over the years the language would change but it hasn’t; Loan Originators around the country still say “pull your credit” when they talk with consumers about obtaining their credit report.
The Credit Inquiry Myth:
Some people believe that every time you check your credit score it drops 30, 40 or even 50 points and that is simply not true. In fact the credit bureaus understand that when you obtain a mortgage or a car loan it’s smart to shop around so they allow for some credit inquiries and it will not impact your credit score.
If you decide to apply for four or five credit cards at once then you might see a few points here are there but nothing significant. The biggest thing is paying your debts on time and don’t max out your credit cards.
Here Are The Important Credit Score Levels:
When it comes to conventional mortgages there are eight main “Loan Level Price Adjusters” (aka score ranges) that are important to the approval process. The higher the credit score the better the rate (generally speaking).
- 619 or under is the lowest level
- 620 – 639
- 640 – 659
- 660 – 679
- 680 – 699
- 700 – 719
- 720 – 739
If homeowner “A” has a 725 credit score and homeowner “B” has a 735 credit score; does homeowner “B” obtain a better rate? The answer is no because they are within the same level. But if homeowner “B” has a 740 or higher score he might be able to lock in better terms that homeowner “A”.
Did you catch the word “might”? The reason has to do with another component to figuring out interest rate and that is the Loan-To-Value ration (aka LTV). If you’re LTV is at or below 60% then you can have a 660 or a 740 – it doesn’t matter; you’ll obtain the same mortgage rate. But if the LTV is 80% you’ll end up having an interest rate thats a.25% to .50% higher.
Some additional things that will increase your interest rate are:
- Cash out loans
- Non-owner occupied loans (rentals)
- If you have a second; that will increase your first mortgage rate
- More than one unit on the property
- If the property is a Condominium with an LTV of 75.01% or higher
When it comes to determining your interest rate on a mortgage there the three main C’s – Credit (or “Character”), Capacity and Collateral. Having an experienced and knowledgeable Loan Officer with a great reputation can really help you understand all the important details.
What Can Hurt Your Credit Score?
Many different things can hurt your credit score; here are the five biggest issues that could negatively impact your credit score:
- Collection accounts
- Missed payments
- Maxing our your credit line
A good thing that has changed over the years is that small medical collections debt must be handled differently then other collection accounts (like an unpaid credit card account with a $5,000 balance). Credit bureaus must wait six months before they can place the medical collection debt on your credit report and once they’ve been paid the must be removed. Also mortgage companies no longer require nor pay attention to small medical collections debt.
What Can Help Your Credit Score?
The best way to help your credit score is to show you can manage debt properly. Have 3-4 credit cards and use them responsibly; actively use your credit cards and make sure the balances never go above 50% of the credit limit (ideally keep them below 35%). Not using your credit cards does not help increase your score.
Understanding your credit report and credit score is a big part of getting a mortgage. Knowing ahead of time that the score a mortgage company obtains will probably be different than the credit score you are obtaining will save you from a lot of confusion and frustration. Being educated as to how your credit score is formed and why it’s important for mortgage companies enables you to be better prepared for when you are ready to apply.