First-time homebuyers look to agents to fill in knowledge gaps. Although you’ll likely be sending buyers to a lender, it’s good to understand and be able to explain the terms. Especially if they tell you a number or hand you a credit report and think they’re set. Chances are, most don’t know that consumer credit scores are not a measure of true homebuying power.
Credit, reports and scores — know the differences
First, let’s start with the basics. Credit, credit reports and credit scores are often bandied about interchangeably, but they’re not the same thing. Credit, according to Experian, is “borrowed money that you can use to purchase goods and services when you need them.”
A credit report contains information about past and current credit accounts. A credit score is “a grade that’s given to your credit report,” according to Wells Fargo.
Credit reports come from the credit bureaus, where information (balances, length of loan, standing) on various kinds of credit (auto loans, mortgages, revolving, medical, etc.) is documented. The three major credit bureaus are TransUnion, Equifax and Experian.
The Fair Isaac Corporation (FICO) calculates what’s reported into scores using proprietary software — this is where the term “FICO score” comes from.
FICO scores are the basis of what most lenders use but don’t include some factors that matter to mortgage lenders (employment, number of credit cards).
The newer VantageScore is making headway with mortgage lenders; traction has increased since December when House Resolution 4211 allowed Fannie Mae and Freddie Mac to use alternate scoring methods.
This method looks at credit reports plus recurring payments (utilities, etc.) and goes back 24 months (FICO looks back six months). This can be helpful for clients with limited or weak credit histories. Scoring used to be difficult to understand, but it has been updated to align with the familiar 300 to 850 model known by FICO users.
If your client has an old VantageScore report, you can refer to the conversion chart, but it’s best to get something current. Be aware that the report compares the individual’s repayment behavior against other borrowers to predict how well they will make payments in the future.
So if a lender starts with a VantageScore that shows a client was inconsistent about paying rent on time, the client might have a lower-than-expected score.
Consumer credit sites
Online consumer-facing sites such as Lifelock and PrivacyGuard use scores that are not the same as FICO scores. They’re known as “educational scores” meant to keep consumers aware of credit history and activity.
Plus, algorithms for mortgages, car loans, retail cards and other forms of credit are calculated differently. Delinquencies and other negative marks are also weighed differently, as well as loan balances and length of credit history. You simply can’t know what your client can afford based on these sites.
What score does a buyer really need?
Federal Housing Authority (FHA) loans have a minimum score of 580.
Conventional and Veterans Administration (VA) loans start with a minimum score of 620.
Bankrate says that for the most competitive interest rate (depending on the lender) the scores need to be at least 740.
Clients with scores lower than 580 can get some loans, but with mortgage insurance and higher interest rates.
If they’re eager to buy now, they can refinance down the road with a good track record of payments.
If you have potential clients who might have credit issues to address before buying, they can start by getting a free credit report (one free report per bureau, per year).
VantageScore uses reason codes that can help borrowers understand items on reports; consumers can only get this report from third-party sites such as Credit Karma, LendingTree and Bankrate (scores should be considered educational).
Buyers should talk to a lender before they try to fix anything on their report — some fixes help and some hurt the home loan process.
Sometimes clients might think their credit is clean, but errors do happen. When the lender pulls up their credit report and score, they might see things that don’t show up elsewhere (like medical bills sent to collections, even those that are paid off).
“People thinking about buying should look at their credit report right away,” said Redefy Contracts Manager Kira Wohlge, who also worked in the credit repair industry. “They should know what’s on it and what belongs to them.”
Which credit report is used for home loans depends on the lender and the program, so don’t make any qualitative statements about lending. To save everyone the headache of offering on a house and not qualifying, connect your client with a lender right away.
In a hot market, sellers can afford to be choosy about offers. “Sellers won’t accept an offer without a preapproval letter in a hot market,” said Paul Barton of Cherry Creek Mortgage in Denver. “If you’re serious about buying a house, you need to show the seller you’re serious.”
You’re not doing your client any favors if you let them house hunt without really knowing what they can afford. Help them to understand credit scores and why they need to talk to a lender for preapproval.