It's a very simple equation. The higher your credit score, the better interest rate you will receive as a borrower.

The reasoning behind the equation is equally simple - your interest rate not only reflects current market conditions but also your estimated ability to pay back the loan.

To a lender, the latter is worth its weight in gold.

Components of a Credit Score:

Generally speaking, your credit score is based upon the following criteria in order of importance:
  • Payment history (this is where delinquencies will hurt you).
  • Responsibility regarding credit usage (how maxed out are your accounts).
  • Credit age (how long have you had your credit accounts).
  • Number of credit inquiry requests.
  • Credit diversity.
These quantifiable aspects, once accumulated, typically result in a number between 350 and 850. The bottom line is the higher the number; the more likely you are to pay back the loan.

What a Credit Score Means

A borrower with an outstanding credit score will get what is called an A-paper loan. This borrower is rewarded with a lower interest rate because of their proven track record. Consumers with less-than-perfect credit receive loans labeled A-minus, B-paper, C-paper or D-paper. These loans are known as "sub-prime" and come with a higher interest rate. On a monthly basis, this translates into more money out of a borrower's pocket.
Improving Your Score

Now that we've explored the nuts and bolts of credit scoring, let's examine how you can improve your score. For starters, it's a good idea to consult with a qualified mortgage professional. An originator can provide examples of reasonable credit usage, discuss options for paying off existing debt, and advise you regarding whether limiting or expanding your credit is most beneficial. A mortgage consultant can also assist you with identifying negative items or potential errors on your credit report. It's important to deal with such issues as soon as possible. In addition, if you need credit counseling, a mortgage professional can help you to obtain it.
Here are some additional tips to keep in mind:

  1. Pay your bills in a timely manner - Paying bills on time for one month can raise your credit score as much as 20 points.
  2. Control the balances on your credit cards - Maxing out credit cards can lower your score as much as 70 points.
  3. Don't open new lines of credit you don't need - New accounts lower your average account age which, in turn, may lower your score as much as 10 points.
  4. No credit is bad credit - Having a few credit cards which you manage responsibly is a good thing. Having no credit cards will reflect negatively on your credit report.
  5. Don't start closing accounts - Closed accounts still show up on credit reports. You should be sure to consult with your mortgage professional prior to closing any accounts in case it will negatively impact your overall score.
Next Steps

Once you have improved your credit score, a mortgage originator can re-examine your financial status and help you to determine whether obtaining a new loan or refinancing an existing one would be beneficial.

In the case of a refinance, a mortgage professional will first determine if your existing loan has a prepayment penalty. If it does, you can work with the originator to continue to improve your credit score until it expires. Once this occurs, your mortgage professional can help you obtain a new loan; one with less than a two-year prepayment penalty so you can continue to refinance as your credit score increases. It's advisable to keep refinancing until you reach A-paper status, securing the best interest rate available.

Loans and credit scores can work against each other, but a good mortgage professional can provide the proper guidance, ensuring a symbiotic relationship.

     Jeff Kutnick
     President First Rate Lending