The typical consumer purchasing a home is completely subject to a score that is given by the Federal Housing Finance Agency (FHFA). It’s the reason that mortgage lenders have to consider things such as debt-to-income, assets, and credit score when deciding whether or not a loan applicant is eligible to borrow. Without that FICO Score, there’s not much point in having a credit score at all, as no lender can take the time to learn all of the details of an applicant’s credit history before making an important decision. However, if someone wants to find out their FICO Score, they can do so. Let’s have a closer look at what a FICO Score is.
What is a FICO Score?
A FICO Score is a three-digit numerical score that is provided to a consumer by the company known as FICO. It’s used by lenders when evaluating and qualifying potential borrowers for a loan. FICO has also gotten involved in other areas, such as consumer and small business credit monitoring, fraud detection, and dispute resolution services. If you’re not sure how to get your FICO Score, it’s a relatively simple process, as outlined here.
How Does a FICO Score Work?
To get a FICO Score, you have to first be approved for a loan from a lender. Typically, lenders will then report your FICO Score to the FHFA. The score that the agency produces is the result of a composite of the information that lenders get from you. It tells them how likely you are to pay back your mortgage, or how likely it is that they’ll have to foreclose on your house if you don’t. Notably, a credit score is not something that is given to consumers based on their own records. It’s instead based on how much data lenders collect about their borrowers. In other words, it’s a score given to lenders based on the people that they want to lend to.
Credit scores are created and updated each day by FICO. The company is constantly making adjustments to the way that it calculates data. It makes any updates through more detailed data collected from consumers. When you apply for a new loan, you’ll be asked to provide more details about your spending habits. In many instances, that information is used to update your FICO Score. Most lenders have adopted certain formulas when calculating the data, they use to calculate FICO Scores. For instance, lenders frequently look at data such as:
- Payments and accounts in good standing
- Loan to value (LTV)
- Length of credit history
- Other data points can include:
- Previous FICO scores
- Credit card balances
- Residual balances on credit cards
- Home equity loan balances
- Loan amounts and terms
Although the FICO Score may not be easy to understand, understanding what’s being measured and how it’s calculated is essential to making wise financial decisions. Although you may not understand exactly what a credit score is, there’s no denying that understanding it can be important to your financial well-being.
How is a FICO Score calculated?
The FICO Score is calculated in several steps. The first step involves an applicant creating a FICO Score report. An applicant can easily download their report by following these steps:
- Visit the FICO Score Administrator’s website. Submit an application (Form L-835) to receive a Score.
- Complete the form to be reviewed by a certified FICO Score consultant.
- Receive a complimentary copy of your FICO Score.
- Download your score.
Once the applicant receives their score, they should review it to ensure that the information provided is correct. The score itself isn’t a secret, so people shouldn’t be afraid to share their score with others. Any mistakes can be easily corrected, and scores are customizable to different industry organizations. The most common mistakes are overstating of assets, making too much debt, or making personal information incorrect.
While a FICO Score is not always a guarantee of whether or not an applicant will be approved for a loan, it does give potential lenders a good indication of how likely an applicant is to repay the loan. Also, a FICO Score is a comprehensive look at the credit profile of an applicant. This allows lenders to see the potential risk an applicant represents, which can be used to make more informed decisions in the future.
FICO Scores and the Home Mortgage Applicant
The first thing lenders look at when evaluating an applicant’s credit profile is a FICO Score.
Because a FICO Score is supposed to be able to predict a borrower’s likelihood of repayment, if a score is too low, it can be a major problem. The more errors a borrower makes on their report, the less likely that lenders are going to want to take the risk of lending to them.
While most of the time, lenders will want to work with borrowers whose FICO Score is in the “prime” range of 640 to 780, this does not necessarily hold true in every scenario. For example, the FICO Score above is an overall score and doesn’t take into account other factors such as:
- Borrower’s credit history
- Credit utilization ratio
- Amount of revolving debt
- Increase in length of credit history
- New or existing late payments
- Insufficient sources of income
- Loans-to-deposit ratio
Compare FICO Scores and their Target Minimum Income
Before you apply for a home mortgage, you need to do some research and compare FICO Scores and their target minimum income, or TMDI. Your TMDI represents the amount of money an applicant will be making in monthly repayments, based on the information provided in their TMDI file. TMDI can help lenders determine whether or not they’re financially able to provide the borrower with the appropriate financing. The higher your TMDI is, the more money the borrower will be able to qualify for in a home mortgage.
Depending on the source of the TMDI information, you may be able to get the TMDI file by going to the FICO® Score Company’s website, contacting them directly, or a number of other potential sources, but there is a common TMDI used by all major lenders. This TMDI includes some of the same information you get from the FICO Score, but doesn’t include any numbers on the amount of debt a borrower has. It is often said that the value of a FICO Score increases when you have a higher TMDI, but this is not true. In fact, the opposite is true. The more debt a borrower has on their TMDI, the less likely it is that they will be approved for a loan.
A high TMDI is the key factor to a higher FICO Score. A low TMDI will usually cause a higher FICO Score, but this is not always the case. A borrower may be able to apply for a loan with a low TMDI if they have other key factors that will bring them above the threshold for the mortgage. For example, having a high FICO Score, the loan will have a lower total cost of funds, and will be easier to pay down. The one exception is that you will generally have a lower FICO Score if you have negative equity in your home. As a homeowner, you will want to be on the low side of your TMDI, so that if you ever need to sell, you won’t have a lot of financial burden.
Negative Equity and FICO Scores
Negative equity in your home may raise your TMDI. Lenders may want to see some sign of financial stability in a borrower’s finances to verify that they can afford the mortgage and pay it back in the future. To see a TMDI that is high enough to qualify for a home mortgage, you should also be able to bring down your monthly payment. If your monthly debt payment exceeds your monthly income, the lender will not be willing to lend money to you. The loan amount will be much higher than the requested value, and the loan will need to be much lower than the value of the home to make it a viable option.
If you have a FICO Score under 620, lenders will likely require your LTV to be below 80%. LTV stands for “liability percentage”, and represents the percentage of the home’s value that you’re borrowing. The higher this value, the higher the monthly payment, and the lower the debt-to-income ratio. For example, if you’re borrowing $100,000, you should be able to make a monthly payment of less than $3,000 for the life of the loan. Lenders may also require the same amount of equity in your home, in order to ensure that the loan will be paid off quickly.
They will be more likely to accept a loan with a lower LTV, but your payments and your debt-to-income ratio will still be the same. Lenders may also look at your credit history in order to make a loan decision. They will be more likely to loan you money if you’ve had good credit in the past, or if you have a lot of high-quality credit. Having poor credit in the past can decrease your FICO Score, making it more likely that you will not be able to get a mortgage.
Your credit history also affects your FICO Score. As you go through life, you will open new accounts, close old ones, and use other forms of credit in order to make purchases. There are four types of credit that lenders will consider:
1. Retail credit cards
2. Credit cards with no annual fee
3. Credit cards with an annual fee
4. Credit lines of credit
You will want to pay your credit cards in full each month, in order to avoid getting an APR that is too high. High interest rates on credit cards can raise your APR, which may reduce your available credit, and your FICO Score. These credit cards also typically have small credit limits, making it easy to pay off the balance every month. Another type of credit card is the debit card. Because these are essentially your only form of credit (whereas most credit cards allow you to use up to a certain amount of your available credit), if you don’t pay them off in full each month, they can be an excellent way to rack up credit card debt, which can make a bad FICO Score even worse.
You can use an app to track your credit cards. The app will send you an alert to see if you have any outstanding balances, and will save the balance for you, making it much easier to avoid any purchases you shouldn’t make. Keep in mind that if you already have an existing credit card, or if you already have a debit card, a credit card is unlikely to save you from spending more money than you’d spend with a debit card. It is best to only get a credit card when you have the money to pay it off in full each month.
FICO Scores – Conclusion
Your FICO Score is based on a formula called the “Leverage Ratio”. The larger the value of the equation, the more leverage you have over the creditor. The lower your credit Score, the less leverage you have over the creditor, which could cause the lender to increase the interest rate on your mortgage. Your credit score will not go down, even if you pay your bills late, unless you are a total deadbeat. This is why it is important to pay your bills on time. There is a system in place to recognize late payments, and there are some minimum fees that you must pay to protect your credit Score. If you make sure that you pay all of your bills on time, you will avoid this penalty.
The score may also change if you are applying for a mortgage. Mortgage lenders may be more likely to accept your application, if you have a higher credit Score, or if they are more likely to purchase your home. Your FICO Score can be even higher, if you have a low debt-to-income ratio, or if you have a very good payment history. Your FICO Score should be a part of your mortgage application, and it will impact how much you can afford to borrow.