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Big Bucks, Better FICO Score?
QUESTION: We were talking to a lender about possible mortgage choices. He mentioned several programs that were reserved for people with high credit scores. Why is it that the rich have access to such programs but not the middle class?
ANSWER: It’s easy to equate a high credit score with high income but there’s no correlation. When it comes to credit scores, income is not even a factor. Wealth – by itself – does not matter.
Credit score pioneer Fair Isaac Corp., a software company based in San Jose, California (see MyFico.com), invented the credit risk score, or FICO score. The score, often used by lenders to determine which consumers qualify for mortgages, is based on five factors, each weighed differently:
1. Payment history (35 percent of the score):
Do you consistently pay your bills in full and on time?
2. Debt (30 percent):
When is a given level of debt too much? One way to tell is to look at your available credit balances and compare them with what you actually owe. This is your credit utilization ratio. The smaller the ratio, the better. Another consideration is whether credit card accounts are maxed out.
3. Credit history (15 percent):
Longer credit histories make it easier to understand how well you use your credit over time. Accounts open an average of five years carry more weight than accounts with a four-month average.
4. New credit (10 percent):
How well do you control the number of credit accounts you open and how much debt you add? Be choosey and disciplined about the credit accounts you open. Multiple inquiries from lenders for your credit score in a short period of time can bring down your score.
5. Credit mix (10 percent):
The scoring system likes to see a mix of credit use: some revolving credit such as credit cards and some installment credit including, perhaps, a car loan. The Federal Reserve said that in February Americans had $937 billion in revolving debt and $2.6 trillion in installment debt, including loans for mobile homes, education, boats, trailers or vacations.
These five factors do not directly involve income. It is perfectly possible for someone with an entry-level job and a good credit payment history to have a higher credit score than the richest person in town.
What credit scores really tell us in not who is rich but who is financially responsible. They’re not a measure of how much you earn, but how you use your money.
When a lender wants a high credit score in order to originate a mortgage, all it’s saying is that it wants to deal with borrowers who are most likely to repay their debts.
In turn, because such borrowers represent less risk, the lender will compete for their attention by offering lower rates.
Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to firstname.lastname@example.org.View Foreclosure Article Archives
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