Analyzing Grading Credit History

Most conforming and many non-conforming lenders today do not perform the detailed analysis of the credit report that they did during the 1990s. Mortgage lenders are more frequently relying on the consumer credit scores, although some review of the credit details are still performed. The future trend, as the mortgage industry becomes even more automated, will be an even greater reliance on credit scores.

Nevertheless, credit scores are derived from the applicant's recorded credit history. This article section will analyze credit grading in detail, starting with the nuts and bolts and concluding with interpretations of credit scores. When analyzing the credit report, mortgage lenders concentrate on the negative entries. Specifically, lenders look for five types of potentially adverse entries:

1.

Insufficient entries

2.

Recently opened credit accounts

3.

Late payments

4.

Current delinquencies

5.

Judgments

6.

Credit grade

If any of the above are found in an applicant's credit report, the applicant must provide a letter of explanation—with supporting documents, if necessary—before the lender can give full approval.

Insufficient entries

The first step to grading a credit report is to count the number of entries and determine their adequacy.

A-grade credit will require at least four or five active credit accounts. Applicants with no active (open) trade lines, but with good previous account histories, are usually considered B-grade. However, it is rare for any American adult to truly have no credit. For instructions on how to quickly build credit, please review the "Building Credit" article in the "Damaged Credit Options" section.

In addition, each credit entry must meet different program restrictions. For example, most lenders require the active credit accounts to be at least 12 months old to be considered. The credit accounts should also indicate the most current reporting date.

Recently opened credit accounts

New accounts and potential liabilities can be a problem because they can lower the applicant's net worth and increase the applicant's debt-to-income (DTI) ratio to levels that may lead to rejection.

Specifically, lenders will review the inquiries section. The applicant must confirm whether or not any inquiry entry resulted in a credit account or loan. If so, that account should be included in the credit report and in the applicant's liabilities calculation. Lenders are obviously concerned about hidden liabilities that may threaten the applicant's current qualification or future financial stability.

Late payments

As mentioned earlier, credit reports do not consider a payment as late until it is at least 30 days past the due date. By the way, the difference between a delinquency and a late payment is that the delinquency still hasn't been paid.

When counting late payments, lenders focus primarily on the past two years. Mortgage lenders also place more weight on certain accounts than others. Lenders prioritize four types of credit accounts as follows:

  • Mortgage and rental accounts. Obviously, mortgage lenders must put the greatest weight on the applicant's past history with mortgage loans and housing payments.
  • Installment accounts. Loans with specific monthly payments are given almost as much weight as mortgages. Mortgage loans, in fact, are forms of installment loans. The common trait is regular monthly payments and the obligation to pay those debts regularly. These accounts include car, student and signature loans.
  • Revolving accounts. Credit cards are normally called revolving debts because the monthly payments will vary from month to month, depending on the account balance for that period. Mortgage lenders are normally more lenient with late payments on revolving accounts than they are with late payments on installment and mortgage debts.
  • Other accounts. Utilities, lay-aways, debts with irregular payments and commercial loans from the applicant's company often fall into this miscellaneous category. They are often not reported; when they are reported, they are usually not given as much weight by mortgage lenders as the other types of accounts.

Current delinquencies

Current past-due amounts are highly detrimental to a consumer's credit grade because it indicates current problems. If there is more than one delinquent account, most lenders can deduce that the applicant is having financial problems.

Very serious delinquencies become collection accounts. In such cases, the creditor has failed to persuade the consumer to bring their account current and has turned the account over to a collection agent. If the collection agent fails, creditors can then turn to civil courts for a legal judgment against the borrower.

Conforming loan programs will accept an applicant who has a delinquency, but will normally require that delinquency to be paid off prior to approval and closing.

Judgments

Civil court judgments against the applicant are often the most serious negative entries in a consumer's credit report, because judgments are normally the final stage in a long delinquency. Credit accounts will only lead to judgments after collection and default.

Other types of judgments include bankruptcies and foreclosures. These actions are court-ordered procedures that do not happen overnight.

Although bankruptcy is the single most detrimental credit rating, borrowers who recover from bankruptcy proceedings and demonstrate the ability to manage their finances should not be severely penalized. The date of discharge is the date used for analysis. A person may file for bankruptcy protection today, but the discharge may not occur until next month or next year or next decade. Borrowers who have been discharged from their bankruptcy within the past two years may be considered only if the bankruptcy was caused by circumstances beyond their control and if the applicants have since repaired and recovered their credit.

Conforming lenders will not accept applicants with recent foreclosure or bankruptcy judgments, unless those judgments are small and have been settled.

Credit grades

Credit is generally graded according to familiar letter grades. Negative entries progressively damage the consumer credit rating. But it is not enough to simply avoid negative entries. The consumer should also demonstrate that he or she can manage credit. Thus, maintaining strong credit is a proactive task; having no recorded credit experience is not good enough to show adequate credit management.

Credit scores, sometimes called FICO scores, arose out of established industry standards that all lenders used prior to 1995. The matrix below lists the credit scores normally given for A+, A, B, C and D/F credit. Note the following clarifications:

  • Mortgage lates refer to a payment that is 30 days late. A payment that is 60-89 days late counts as two (2) 30-day lates; a 90-day or more late payment is counted as three 30-day lates.
  • Lenders distinguish between delinquencies during the past 12 months and the past 24 months. Note that the lender's underwriter will not overlook late payments prior to the last 24 months, but the greatest focus will be on the most recent period.

With regard to bankruptcies and foreclosures, the time requirement indicated begins with the discharge of the bankruptcy or foreclosure, not the filing date.

The following is a useful credit scoring matrix that you can use to measure your credit grade.Credit scores can range from about 350 to about 835, depending on the credit bureau. Note that different lenders have slight variations as to the dividing line between A+ and A, or A-and B, etc.. This matrix does provide an industry average for residential mortgage loans.

A+

A

B

C

D/F

Score

720+

650-719

580-650

500-579

<500

Mortgage lates last 12 months

0

<1

<4

<6

>6

Mortgage lates last 24 months

0

<2

<4

<8

>8

Installment lates last 12 months

0

<2

<5

<9

>9

Installment lates last 24 months

0-1

<3

<6

<12

>12

Revolving lates last 12 months

0-1

<3

<6

<12

>12

Revolving lates last 24 months

0-2

<4

<8

<12

>12

Collections last 12 months

0

<500 (paid)

<$1,000 (paid)

>$1,000

>$5,000

Collections last 24 months

0

<$1,000 (paid)

<$2,000 (paid)

>$2,000

>$5,000

Charge-off/Judgment 24 months

0

<$1,000 (paid)

<$2,000 (paid)

>$2,000

>$5,000

Repossessions

>7 yrs

>5 yrs

>2 yrs

1-2 yrs

<6 mos

Bankruptcy

>10 yrs

>5 yrs

>2 yrs

<2 yrs

<6 mos

Foreclosure

>10 yrs

>7 yrs

>3 yrs

<3 yrs

<6 mos

The following offers a quick translation of what those letter grades actually mean or require:

The following offers a quick translation of what those letter grades actually mean or require:

  • A-grade borrowers have excellent or very positive credit history. They usually have credit scores of 650+, with A-plus credit starting at 720. Conforming loan programs require A-credit of its applicants. In the mortgage industry, A-credit borrowers must satisfy all of the following requirements: (1) no foreclosure or bankruptcy within the past seven years; (2) no late payments on their mortgage history during the past year and no more than one late payment in the past two years; (3) no more than one late payment on any installment loan during the past year and no more than two during the past two years; (4) no more than two late payments on revolving accounts during the past year and no more than four during the past two years; (5) no open collection accounts; and (6) a credit score of at least 650. A-grade borrower must have at least four or five open accounts recorded on the credit report.
  • B-grade borrowers have good but slightly flawed credit. They usually have credit scores between 580 to 650. Conforming programs tend to deny B-credit applicants. However, B-credit applicants usually have a good chance of improving to A-credit in a relatively short period of one to two years. In the mortgage industry, B-credit borrowers normally have one or more of the following traits: (1) no bankruptcies or foreclosures in the past five years and no repossessions or major judgments in the past four years; (2) three to six late payments on mortgage and installment debts during the past two years; (3) five to eight late payments on revolving debts in the past two years; (4) unpaid collections of $500 to $10,000. Note that a borrower with no recorded credit history is normally graded B.
  • C-grade borrowers have damaged credit, but their credit records will often show some glimmer of effort. C-grade consumers are usually delinquent on several accounts, and demonstrate an inability to efficiently manage debt; they usually have credit scores obetween 500 to 579. For most C-grade consumers, their only financing hope would be with non-conforming loan programs. In the mortgage industry, C-credit borrowers usually have one or more of the following traits: (1) a bankruptcy, foreclosure or repossession during the past two to three years; (2) at least 60-90 days behind on mortgage or large installment debts ; (3) at least nine late payments on revolving accounts in the past two years; and (4) more than one open collection account. However, with proper attention to debt payments, a C-credit borrower can usually return to A-grade within two to three years. If there has been a bankruptcy, foreclosure or repossession in the past two years, the borrower can still salvage a C grade by showing that he or she has made strong efforts to regain creditworthiness.
  • D-grade borrowers have tremendously damaged credit, with no recorded display of recovery. Some lenders label this level E-grade or F-grade, but the net result is the same. The only financing hope for D-credit borrowers would be expensive non-conforming loan programs. D-grade borrowers are often currently in foreclosure, bankruptcy or repossession—or have just completed such actions within the past year. Consumers can still be graded "D" when the foreclosure, bankruptcy or repossession is two to five years old if that consumer has not made strides in rebuilding credit. However, with proper attention to debt payments, a D-credit borrower can usually return to A-grade within five to seven years.

Different lenders establish and regularly adjust their own credit-grading criteria. Some lenders are more lenient than others. In general, however, lenders with the most attractive loan programs and pricing often impose the tightest requirements.

If you have damaged credit, we recommend that you review the "Damaged Credit Options" and "Repairing Damaged Credit" articles.

We hope that you've found our Mortgage and Real Estate Resource helpful and informative. We welcome all comments, critiques and suggestions; please send emails to [email protected]. Remember that whether your are buying a home or an office building, you are investing in real estate. As with all investments, the best investors are those who can gather the most knowledge, tools and resources. Regardless of whether you use our lending services, please spread the word about our resource center to anyone you know who may benefit from our site.

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