Your FICO Score: The Three-Digit Number Explained
What’s My Interest Rate?
Getting a great interest rate takes more than you might realize.
So, you’re shopping for a home and you need a mortgage. You’ve gone online and looked at sites like, www.bankrate.com and www.lendingtree.com and you’ve determined that you should be getting an interest rate of 5.625% for a 30 year fixed rate mortgage. After all, the website said so! What’s missing from this story are three very important components of your specific situation (and what you have to pay for that rate. We’ll cover that in a later article). These components are your credit score, loan purpose, occupancy, number of units, product type, etc. All of these are important but your credit score or FICO, the size of the loan you need and how large that loan is relative to the value of the home (also known as, the Loan-to-value ratio) that is the starting point for a rate discussion. Below, we’ll look at each of these three specific components, one at a time. When I have explained each component, we’ll then come back to the underlying topic of this article, Fannie Mae’s Loan Level Price Adjustments.
Before we go there, Fannie Mae or the Federal National Mortgage Association (FNMA) is a government sponsored entity (GSE) that was set up after the great depression to expand the market for mortgage loans. Fannie does this by creating a multiplier effect allowing lenders to reinvest their assets after selling the home loans. The buyer? The federal government and they buy in the form of mortgage backed securities. Fannie Mae has a brother named, Freddie Mac or the Federal Home Loan Mortgage Corporation (FHLMC). They operate as a GSE also. Each GSE has guidelines that lenders and banks must follow if they want to have their loans purchased. Ok, enough history, let’s get into it.
FICO. Knowing what your credit score is the very first step to understanding your credit rating and how it impacts your ability to get credit. Most borrowers that I speak to will tell me, “Oh, I have a 780 score,” and when I ask how they know, they say, “My (enter the name of your favorite credit card) gives me my credit score every month.” That’s perfect. The number that you get from your credit card company is a great start, but it won’t be the score I or any other lender will get to use. When we submit your loan application to the bank for approval, we’ll use another source and that source will look at three scores! The FICO we must use comes from a credit reporting agency that queries each of the three credit bureaus (Equifax, Experian and TransUnion). Yeah, I know, agency, bureau, what’s the difference?
A credit reporting agency is a company that works with companies that extend credit to borrowers to get regular updates on your payment history. There a many, many of these companies. The credit reporting service then regularly delivers your payment history to the credit bureau with which they have an agreement. Big companies like American Express or Visa have agreements will all three bureaus (Experian, Equifax and TransUnion). Some smaller creditors (those businesses who extend credit) may work with a credit reporting service that only works with one of the bureaus. So, when they report your payment history, it may only get reported to one bureau. Does this mean that you don’t have to worry if the vendor you paid late or not at all only reports you to one bureau? Nope. Always protect your credit rating, no matter who you use to established credit or payment terms. The easiest way to do that is to pay your bills on time. Simple.
Here’s how mortgage lenders see your credit when they submit your loan application. They also use a credit reporting agency. Again, there are many. That agency then queries all three bureaus to determine what your credit history looks like and each will issue a score based on what information they have about your payment history. So, here’s an example:
John Robert Borrower (JRB) is going to apply for a home loan. He completes his application and gives the mortgage lender permission to pull his credit history. The lender asks its credit reporting service to issue a “Tri-Merged” report (“Tri” for the three bureaus and “merged” for you guessed it, a merged report) for JRB. The report comes back and shows that Equifax gives him a 707, Experian gives him a 715 and Transunion gives him a 739. When we go to determine JRBs credit worthiness for a home loan, we are going to use the middle score of these three as his official credit score. In this example that would be 715. This is the first of the Loan Level Adjusters we’re looking at today. Let’s look at the next two.
Loan size. Is that your loan or are just happy to see me? Ok, ok, I know. Lame. These are the jokes, people. But size DOES matter. I know. I just can’t help it. In all seriousness though, the size of the loan will impact your interest rate. Huh? Let’s break it down.
Fannie Mae is a GSE that buys loans from mortgage banks and traditional banks. Fannie Mae sets the conforming loan limits for all counties nationwide. They determine what the conventional conforming and high-balance loan amounts are for each county. Here in the San Francisco Bay Area, those limits are as follows; up to $726,200 is considered a conventional conforming loan. From $726,200 to under $1,089,300 is considered conventional high-balance. Any loan larger than $1,089,3000 is considered a jumbo loan. There are loans that are larger than $1,500,000 that some call super jumbos, but we won’t cover those as they are beyond the scope of this article. And that’s all I have to say about loan sizes. For now.
Loan to Value Ratio. The last of the levers that we need to discuss is Loan to value ratio (LTV). Essentially, this is the ratio of your loan size to the appraised value of your home. So, once again, size matters. When we buy a home most of us have been told that we need to have 20% down. This means you have a loan to value ratio of 80%. The more money down, the lower your LTV is going to be. Oh, and if you happen to have less than 20% to put down, there are programs out there to help you with down payments and that will allow less than 20%. So, don’t count yourself out if you don’t have 20% to put down. Look for my contact info at the end of this article. When you reach out, we can go over your options.
Once you have purchased your dream home, we hope that it will appreciate. Here in the SF Bay Area, we unprecedented appreciation over the past few years. Amazing, right? It would be hard to plan on that appreciation continuing at the same pace but stranger things have happened with California real estate. As they say in any investing prospectus, past performance is no guarantee of future gains. Plan accordingly. There it is. LTV. The final component in our complicated equation.
So, now that we know there are three components to deriving what your rate will be and we know a little bit more about each one, let’s explore how they come together. To do this, we need to create another borrower. Earlier in the article, we met John Robert Borrower. JRB had a middle credit score of 715, which is OK but now we’ll meet Patricia Perfect. Patty has a middle credit score of 741. This places her in lowest risk category, according the Fannie Mae guidelines. A borrower with a credit score of higher than 740 happens to fall into the lowest risk category. Does each LLPA have a lowest risk category? Why yes, I’m glad you asked.
In addition to the credit score, we also need to be looking at the loan size. Any loan that is smaller than the conforming loan limit of $726,200 here in San Francisco Bay Area also falls into the lowest risk category.
The final risk category is the loan to value ratio or LTV. Any loan that has an LTV of less than 60% lands in the lowest risk category.
So, there it is. FICO of 740 or higher, loans that fall into the conforming category and have an LTV of less than 60% are going to get premium rates. There are other ways to get great rates too but again, that is beyond the scope of this article.
One final note. Today, we are talking about owner occupied, single family detached residences. If we use these three criteria to determine interest rates for the purchase of this type of home, we can be pretty certain that we’re going to get an accurate rate and APR quote. So, again, typically, the best rates go to those borrowing less than the conforming loan limit of $726,200 here in the SF Bay Area, where the loan to value ratio is lower than 60% and where the middle credit score is higher than 740. By the way, if you and someone else (like your spouse, sibling or even a friend) are both on the loan application, we’re going to use the lowest middle score from either of you. So, if JRB and Patty are married or going in the same purchase, we’ll need to use JRBs score of 715, not Ms. Perfect’s 741.
Hopefully, this makes sense. You can post your questions here or email me directly. Are you currently looking to buy a 2, 3, or 4-unit home, second or vacation home, investment property or take cash out for home repairs or debt consolidation? Fannie Mae has additional Loan Level Price Adjustments that will be applied to these types of loans. Do you want an exact rate quote and phenomenal service? Contact me at email@example.com
The Case for an Adjustable Rate Mortgage
Perhaps a good place to start is to understand what an Adjustable Rate Mortgage is and why you might consider one? “ARM” loans, as they are commonly known, are a hybrid loan that employs a fixed rate for a predetermined period. That can be 3 years, 5 years, 7 years and even as long as 10 years. Once the fixed period is over, the loan then “Adjusts” based on a market indicator like LIBOR, usually once a year.
For some, ARM-type loans are an ideal product. They fit short term goals nicely, if your plan is to sell your home inside of one of the predetermined periods. ARM-type loans are also a great fit for folks that want to stretch their hard-earned dollars further or increase their buying power. This can be especially true for borrowers here in the San Francisco Bay Area where FHA Loan Limits are at their highest but property prices are much higher. The ceiling for conventional loans was recently raised to $679,650, as of January 2018 but again, conventional loans are simply not large enough for most purchases in this market. So, if you are searching for a home loan and with rates on the rise, an Adjustable Rate Mortgage might be in order.
Here’s some support for an adjustable rate mortgage. While we have been enjoying an historically low target federal funds rate, the March 2018 target federal funds rate increase could wind up impacting your affordability. What does that mean? Basically, for every quarter point increase in your mortgage interest rate, your monthly payment increases, which results in a small loan amount. Huh? Yeah, I know. Here’s a quick example:
Say you are looking to purchase a home for $1,250,000. Your 20% down payment ($250,000) results in the need for a loan of $1,000,000
Under the fixed rate scenario in the right column, your payment is $221 more per month—significant over the life of the loan, right? The bigger issue is if that extra $221 per month pushes you over bank’s the DTI cap or you simply cannot afford an additional $221 added to your monthly budget. If either of these are true, you’ll need to either come in with a larger down payment or get a smaller loan. This could result in you not being able to afford that home you really want.
Let’s make that real: to keep your payment the same at the 30-year fixed rate of 4.5% (4.524% APR), as it would be under the 7/1 ARM rate of 4.125% (4.585% APR), you’ll only be able to borrow $957,000. See how that works? Affordability due to a lack of inventory is already a real issue here in the SF Bay Area. With inflationary pressures and continued movement by the FOMC to minimize said inflation through increasing the target federal funds rate, mortgage rates will impact affordability even more so.
Lest there be any question about what affordability means, the US Department of Housing and Urban Development (HUD) over time has set a 30 percent threshold for owner-occupied housing, and it remains the indicator of affordability for housing in the United States. This means those spending more than 30% of their household income on their housing costs are considered to housing cost burdened.
Here comes the tough part; some believe that increasing mortgage rates will ease the affordability issues we’re facing here in the SF Bay Area by putting downward pressure on prices. Unfortunately, according to a recently published paper by Freddie Mac this is not the case. In that study, they note that in 1993/1994 when mortgage rates spiked 2.4%, housing prices continued to increase by 3%. Mortgage originations and housing starts on the other hand dropped by as much as 13%. So, the effect of increasing rates truly falls to the borrower and the overall economy. Either borrowers put the purchase on hold and continue to rent or they look at lower priced homes—something that isn’t very reasonable here in the inventory strapped SF Bay Area. Look at the graphic above for the results of that study.
Let’s dig a little deeper on that to understand how the pieces come together. Your ability to repay relies, in part, on your debt-to-income (DTI) ratio. As your monthly payment goes up, so too does your DTI. (When I cover Fannie Mae’s Loan Level Adjusters, we’ll go over the other factors). As your DTI increases, something must give. This typically means a lower loan amount, which should keep your monthly payment the same or similar. ARM rates, generally, are lower than 30 Year Fixed Rate mortgages, so going with an ARM can help you stay on track with the loan amount that helps you win the purchase.
So where is the pressure coming from on interest rates in general, you ask? Unemployment is down, nearing record lows and inflation remains relatively high. Raising the prime rate is just one way for the Federal Reserve to ensure that it is doing its part to keep inflation at bay while keeping the economy humming along.
So, the real question is: Should you go with an ARM loan or a traditional 30-year fixed loan? Only you can answer that question. However, here is some food for thought as you mull over your decision. 30-year fixed rate mortgages are resetting to their highest levels since January 2014. Still, these rates are historically low. If you are looking to purchase a home, ARM-Type loans are pricing at slightly lower rates for 3/5/7/10 years. FYI, 7/1 ARM products tend to be the right fit for most, but everyone’s circumstances are unique, so talk to your mortgage professional to get information that meets your specific situation. Better yet, call me.
What is “APR” and Why You Should Care
The Annual Percentage Rate (APR), when combined with the Interest Rate and the loan term, can be used to compare the cost of one loan to the next. This comparison allows the consumer to shop confidently for a loan and a lender that makes the most sense for their purchase objectives. The APR also forces the lender to quantify the fees and charges that it is assessing the borrower for establishing the loan.
Full Article Here
There is something funny going on with the mortgage rate you’ve been quoted. That odd acronym “APR” (Annual Percentage Rate) is showing up in your paperwork and it is not the same as the interest rate you are being quoted. What is going on? Why are there two numbers for your mortgage and which one is more important? Shouldn’t you just care about the rate? The answer is easy. You should be looking at both.
The Annual Percentage Rate includes the true cost of the loan and is required to be shown in any advertised rate quote so that you, the consumer, can make an informed comparison of multiple quotes before choosing a lender.
In fact, while both are important, the APR is probably more important than the rate. Why? The Annual Percentage Rate is the rate that reflects the cost of the loan. Huh? Yep, the cost of the loan. Included in this number are the fees charged to establish the loan. Things like the appraisal, your credit report and any other fees (like Points) that the mortgage lender or bank is charging you for lending you the money to buy your new home or refinance your current home. I know what you may be thinking: “Wait, what? Is the lender charging me to borrow money? Isn’t that what the interest rate is supposed to do?” Not exactly.
You see, the lender has costs that it needs to cover in originating your loan—they are like any other business after all and must make money. They have expenses too, in generating revenue. These expenses can be things like the appraisal, your credit report, the underwriters, and all the other hand labor that it takes to determine your creditworthiness and to process the loan paperwork. The interest rate just covers the time value of money and the premium that the lender makes on lending you the money over the term of the loan. So, they need to pass these other costs on to you. Or do they?
We’ll cover that last question in a later post but let’s first finish the definition of what the APR is exactly. The Annual Percentage Rate includes the true cost of the loan and is required to be shown in any advertised rate quote so that you, the consumer, can make an informed comparison of multiple quotes before choosing a lender.
Here’s how it is calculated:
- Add up all the fees you are being charged for the loan amount to get an Adjusted Balance.
- Find the monthly payment on the Adjusted Balance.
- Return to the original loan amount, and find the interest rate that would result in the monthly payment found in step 2. This is the APR. You can do this easily in a spreadsheet program.
The folks over at TheBalance.com have done a nice job of showing us step-by-step how to calculate APR
So why should we care about the APR? The APR, when combined with the interest rate and the loan term gives us a true picture of what the cost of the loan is over the entire life of the loan. In general, a lower interest rate with a higher APR will result in higher upfront fees but a lower overall cost over the life of the loan. The combination of these variables can be very telling when shopping for a loan. Armed with this information, we can shop for a lender or loan product that meets our specific needs.
Tune in next time when we cover the various loan types (Fixed vs. Adjustable Rate, etc.) that are available and discuss what factors you should consider when choosing a loan product.
Contact me today at: firstname.lastname@example.org or by phone 650-207-4364 cell
Christian Carr, Mortgage Loan Officer NMLS# 1466899 CMG Mortgage NMLS #1820
About us: Diversified Mortgage Group is a division of CMG Mortgage, Inc. © 2018 CMG Financial, All Rights Reserved. CMG Financial is a registered trade name of CMG Mortgage, Inc. NMLS #1820 in most but not all states. CMG Mortgage, Inc. is an equal opportunity lender, licensed by the Department of Business Oversight under the California Residential Mortgage Lending Act No. 4150025. Offers of Credit subject to Credit Approval. Pleasanton Branch ID#508121. Fremont Branch ID#508123. To verify our complete list of state licenses, please log onto the following website: www.cmgfi.com/corporate/licensing and also www.nmlsconsumeraccess.org. Please contact me at: email@example.com
Winning the FICO Game
How Trended Credit Data Impacts Your Loan
Trended Credit Data takes your revolving credit habits over the last 24-30 months and creates and “average” credit picture for you. There are two types of credit applicants under this new framework – “Transactors” and “Revolvers”.
Key Takeaway: Your long-term payment history will impact your credit score and may even improve your FICO score, possibly leading to better interest rates and overall savings over the life of your mortgage. Read more below…
Millions of Americans have a FICO score. Millions more don’t. The question is, do you know what your FICO is and what it means? Do you know how your spending and payment history can impact your score? Do you know what the minimum acceptable score is to qualify for a home purchase? Did you know that changes have been made to the way that lenders look at your credit history? We’ll look at these questions in detail below. Look for additional posts on your FICO in the coming weeks–specifically Fannie Mae’s Loan Level Adjusters.
The Federal National Mortgage Association (FNMA) or as you may have heard them called, “Fannie Mae” moved to a new system in October of 2016, under which they would begin requiring mortgage lenders to use something called “trended credit data” as part of their underwriting guidelines (These “guidelines” are the rules written by Fannie Mae and are used by the majority of mortgage lenders to determine if you are eligible for a home loan.)
According to Fannie Mae’s VP of Credit Risk Analytics and Modeling, Eric Rosenblatt, “’trended credit data’ is historical data at a tradeline (credit line) level on several monthly factors, including: amount owed (balance), minimum payment due, and payment amount made.”
Fannie Mae, through a large-scale analysis of credit history pulled from almost 4 million consumers, reviewed credit habits from June of 2009 to August of 2012. Their conclusion was that including trended data materially improved modeling of loan performance, ultimately reducing risk.
Fannie Mae wasn’t alone. TransUnion Credit Agency, one of the three agencies that track consumer credit, also happened to learn that the percentage of consumers in the Super Prime risk tier, who generally have the greatest access to new loans at the lowest pricing, could increase from 12% of the population to nearly 21%.
The result for these newly minted to this status is potential access to lower interest rates, resulting in large savings in reduced interest payments over the life of a thirty-year mortgage. Even more important is that nearly 26.5 million previously unscored U.S. Consumers could be effectively scored using trended credit data—affording many the dream of homeownership.
So, how does trended credit data work? The agency has placed consumers into two different categories. The first, “Transactors,” are those consumers making more than the minimum monthly payment or who retire their debts each month. The other, “Revolvers,” are those that run an ongoing balance on credit cards, making only minimum payments and don’t generally pay off their debts but can and usually make regular payments to their credit obligations. The object of dividing consumers in to these two categories is create a richer view of credit worthiness and overall borrower risk. Their view being those that pay off their debts regularly, rather than run a balance on credit line are viewed more favorably. The new framework can also consider a one-time missed payment as out of the ordinary when the borrower is generally on-time with their payments.
Consider the following: if you, as a borrower, fall into the “revolver” category, your access to better interest rates and loan programs might be hindered. So, there is good reason to keep your payments regular and make more than the minimum payment each month. You’ll wind up giving less of your hard-earned money to the credit card companies too. If you want to go deeper on the topic of trended credit data, you can read Michelle Crouch’s article over at creditcards.com
Now more than ever, your excellent credit is the key to homeownership and access to the best loan programs available. Want to learn more and even get pre-approved for a home loan? Contact me today so that we can review your specific needs and circumstances. We’ll work to help you achieve your goal of homeownership by listening to your needs, arming you with information and then getting you the loan that works best for you.
And remember, in this competitive market, shopping without a fully underwritten pre-approval may lead to missing out on your dream home. So, be sure to ask me about fully underwritten TBD loans.