The Credit Score System Could Accurately Predict the Outcome of 70% of all Loans
Credit bureaus have been around for well over 100 years, but credit scores have only been around since 1989. I got into the consumer finance industry in 1987, back then all we knew was how many accounts you had, what your total debt was, and how you paid your bills (on time or slow). It would also tell us if you had collection accounts, charge-offs, repossessions, or foreclosures. With that information we would look at your job time, income, and down payment and make our decision based on those items, it was very subjective. When Fair Isaac invented the first credit scoring system, I have to admit I was skeptical because I felt like it removed the human element from the lending process.
Our credit bureau rep. came in and ask us to give them 500 random loans that had been on the books for at least 3 years or more (they asked us not to give them the pay history), about 6 weeks later they came in to make their presentation and it really blew our socks off. They were able to predict the behavior of each loan about 70% of the time, I have to tell you we were more than impressed. The only question I had was about the 30% of the time when the scores didn’t predict the behavior accurately, these loans performed well in spite of the low score, and I was afraid we were going to end up declining good people that would obviously pay their bills on time. When they showed me the math, it was pretty clear that the profit you would make from the 30% wouldn’t cover the losses on the 70% that would either end up paying slow or defaulting.
Tiered Pricing Allowed us to Provide More Loans While Minimizing the Risk
My company started using a min. credit score to qualify for a loan. About 5 years later we started using a tiered system that would allow us to price the higher risk scores higher than the lower risk scores, this allowed us to make more loans and get paid for the higher risk. Now almost every creditor from auto, credit card, and mortgage companies use a tiered system to price their risk accordingly. This tiered system allows creditors to make loans that they wouldn’t normally originate because they priced the risk accordingly. I got into the consumer mortgage industry in 1999 and tiered pricing was just starting to gain favor. The guys who’d been in it for years were super excited about the changes, they were able to make more loans and since they were priced properly, loans started to perform better, and the industry got more aggressive.
After 2008, The Credit Score Tiered System Finally Started Being Used the Way it was Intended
As some of you may have heard the entire industry got carried away and the entire thing blew up in 2008 due to the housing bubble, greed, and not sticking to the fundamentals of lending. Since the meltdown, Fannie Mae, Freddie Mac, FHA, and VA have gotten back on the right track and they started using the tiered system the way it was intended. Your credit scores don’t only impact the rate you pay, they also can impact the amount you are required to put down. It’s pretty simple if you think about it, the more responsible you are with your credit the higher your FICO scores will be. The higher your credit scores are the lower your interest rate will be and if you’re not putting 20% down the lower your PMI (Private mortgage insurance) will be. PMI can add up to a full 1% to your APR with lower credit scores.
The 3 Kinds of Credit Scores
- Fico Bankcard – this is the scores that credit card issuers use
- Fico Auto Score- this is the scores the auto industry uses
- Fico Scores & Mortgages- this is the one we use
Typically, they aren’t that far apart, but in some cases, they can be up to a 50 points difference. The one that I use is the original (OG) www.myfico.com they have a subscription model with no contract. For those of you applying for a mortgage you’ll want to subscribe to their Premier program, it’s the only place on the internet that I know of that will give you all three types of scores including the mortgage specific scores. We highly recommend that you check out your mortgage specific scores before shopping for a mortgage. All of the super low teaser rates you see online are typically 800-825 min. scores with 20%-25% down, please read the fine print before you start asking for a rate that less than 1% of the U.S can qualify for. By the way, accessing your consumer report doesn’t count as an inquiry, you can pull your own report as often as you’d like without dropping your score.
Don’t Let Your Low Credit Score Stop you From Calling us, we can Help you Raise your Score
The other thing you need to know is that a mortgage inquiry is the least invasive of all inquiries, it doesn’t drop your score like a credit card or auto loan inquiry would. Don’t be afraid to let the mortgage company of your choice pull your consumer report. In the mortgage industry, we, at Rock Mortgage, pull all three credit reports, then we toss out the high and low scores and use the one in the middle to price your loan. Example: Experian 761, Transunion 742 & Equifax 782 your middle score would be 761. Don’t let your low credit scores stop you from calling us at Rock Mortgage. We love it when someone calls us who needs help raising their scores, we’ll put you on a credit restoration plan and tell you everything you need to do to raise your scores (free of charge). I’ve literally closed hundreds of loans in the last 30 years for people who never thought they would qualify for a mortgage. All it takes is a good plan and your willingness to do what’s hard to get you in the home of your dreams.