Landing a mortgage in 2011 is going to be a bruiser. The recession may be over, but mortgage lenders, still feeling the sting of foreclosures, strategic defaults (walk aways), and underwater homeowners are not letting down their guard.
In January, VantageScore, the progressively more popular credit scoring system, delivered its rebooted scoring model, called VantageScore 2.0, to mortgage lenders. This follows on the heels of the rollout in late October 2009 of the revised FICO 8 Mortgage Score by Minneapolis-based FICO, the creator of the ubiquitous FICO score. The two revamped scoring models will place a greater emphasis on borrowers' short-term credit histories, whereas the models use to place a larger emphasis on a borrower's credit use over the long term.
The result: High credit scores just got harder to come by. Of course, there are several keys to having a loan greenlighted, including the amount of the down payment that's available in your bank account (if you're applying for a mortgage), and your annual earnings that prove you can repay the debt. Perhaps the most important factor that a lender considers when deciding whether to grant you a loan--and at what interest rate--is the seemingly larger-than-life three-digit credit score.
Credit score standards rising
Three years ago, the most creditworthy borrower was someone with a FICO score--the most commonly used credit score--of 680 to 700. Now it's 760 and up. FICO scores range from 300 to 850. The higher your score, the better credit risk lenders deduce you are, and the better the mortgage rate you're offered.
For anxious lenders, the revamped scoring models are promising. FICO's new score is anywhere from 15 percent to 25 percent more accurate in predicting defaults than its predecessor, according to FICO spokesman Jeff Scott.
For consumers, however, the new models may pack an inside hook. The hitch: "The firms are secretive," says Keith Gumbinger, HSH.com vice president. "They don't let much out of the bag about how they have recalibrated the models."
Searching for distress
One thing is for certain. "Surveillance keeps getting sharper," says Evan Hendricks, author of Credit Scores & Credit Reports: How the System Works, What You Can Do. The experts agree that the new formulas will hone in on recent credit and payment history in hopes of detecting early signs of financial troubles.
For example, the main tweaking with VantageScore 2.0 is that applying for new credit accounts can ding you more than in the past. Inquiries and recent credit activities account for 30 percent of your score, up from 10 percent, according to company officials.
Less significant are your overall credit balances and the length of your credit history. Those factors account for just 9 percent and 8 percent, respectively, of your score. In the past, they weighed in at 15 percent and 13 percent.
One caveat: While VantageScore is used by all of the top five credit card issuers, four of the top five financial institutions and two of the top five auto lenders, it currently isn't used by any mortgage lenders.
Control what you can
To avoid getting slammed by the new focus on short-term credit histories, here are seven moves to consider:
- Pay bills on time every month: This is the single most important factor to maintaining a strong credit score. Miss a pay date and your score could drop by more than 100 points.
- Lower balances: Another factor that has a strong and immediate impact on your credit score is paying down debt. Your credit score takes into account the amount of credit available to you compared with how much credit is actually utilized. The less you're using, the higher your score.
- Avoid new debt: Steer clear of adding to existing credit balances, or opening new accounts. Both are signs of fiscal stress, Gumbinger says. "If it's a temporary need for cash, consider borrowing money from a family member to tide you over, rather than racking up a new pile of credit card debt, or running willy nilly around town trying to establish credit," he says.
- Don't close accounts: While closing accounts sounds like a good idea, in reality, it lowers your available credit and pushes your current ratio of debt higher.
- Skip co-signing for a credit card or other consumer loan: When you co-sign, the debt is also considered your debt. If the borrower misses payments, this will be reflected in your score.
- Check your credit report for mistakes: Visit annualcreditreport.com to request a free credit report from the three major credit bureaus--Experian, Equifax and TransUnion. The two most-common disputes you're likely to find are medical bills that you thought your health insurance company should pay, but your provider placed into collection, and residual balances on cell phone bills after you've switched carriers.
- Erase one-time late payments: "If 18 months ago, you missed a credit card payment by 30 days, call the credit company, and say, 'I have only had one hiccup, I'd like to get this expunged,'" Gumbinger counsels. "If it's a minor interruption, you should be able to get some response."
While the new scoring models will make qualifying for a home loan tougher this year, hang in there. Scores are in constant flux. Over time, these counterpunch actions can help you improve your credit rating and clinch a deal.
Kerry Hannon is the author of “What's Next? Follow Your Passion and Find Your Dream Job” and covers careers, retirement and personal finance issues for a variety of national publications, including USA Today, AARP, Forbes.com and CBS MoneyWatch. She is based in Washington, DC.