One Partner. Countless Advantages.®

Giving Credit WhereCredit is Due

Understanding Credit Scores

History of Credit Scoring

• Statistical model.• Based on one million borrower profiles.• Used by the three repositories:

– Experian:• Experian/Fair Isaac Risk Model.

– TransUnion:• Empirica.

– Equifax:• Beacon.

The Basic Facts

• Credit scores are a tool.• Credit scoring is fast, accurate,

fair.• Credit scoring is a track record.

The Basic Facts (cont.)

• Scoring models look at the whole picture.

• No score lasts forever.• Credit scores are based on credit-

related information only.

Benefits

• Ensures equitable treatment of all applicants.

• Speeds credit decisions.• Helps make more credit available.• Highly predictive of mortgage

default.

Why Use Credit Scores

• Fannie Mae/Freddie Mac/investors.• Portfolio analysis.• Helps lenders:

– Base credit decisions on relevant credit-performance data only.

– Remove potential bias.– Offer better terms and loan programs.– Control delinquencies and charge-offs.– Improve operating efficiency.

Underwriting and Credit Scores

• Selecting the score:– Scores Equal To Or Greater Than 660 =

Acceptable Credit = Basic Review.– Scores 620-659 = Average Credit =

Comprehensive Review.– Scores Less Than 620 = Fair Credit =

Cautious Review.– Varies by lender and purpose of

financing.

What’s NOT in a Credit Score

• Prohibited by U.S. law:– Ethnic group.– Age.– Religion.– Gender.– Marital status.– Nationality.

Components of a Credit Score

• Payment history.• Amounts owed.• Length of credit history.• New credit.• Types of credit in use.

Statistical Weights

• Reason codes:– Payment history – 35% of score:

• Public records, collection items are considered serious.

• Severity, time-frame, and frequency of delinquencies and public records are reviewed.

– Amounts owed – 30% of score:• Number of balances recently reported.• Average balance across all trade lines.• Relationship between the loan types, total balances

and total credit lines taken into consideration.

Statistical Weights (cont.)

• Reason codes (cont.):– Length of credit history – 15% of score:

• Age of oldest trade line and an average age of all accounts.

• How long specific accounts established and how long since certain accounts used.

– New credit – 10% of score:• Number of inquiries and new account

openings in the last year.• New history of clean credit since last

derogatory reported.

Statistical Weights (cont.)

• Reason codes (cont.):– Types of credit in use – 10% of score:

• Number of trade lines reported for each type:

– Bank cards.– Travel and entertainment cards.– Department store cards.– Finance company loans.– Installment loans.

• Concerns of credit use:– 70% of Americans live paycheck to

paycheck.– Consumers in credit counseling

reported 88% of monthly income went to debt repayment.

– Over 1.7 million filed personal bankruptcy as of September 30, 2005.

Average Consumer’s Credit Use (cont.)

How Consumers Can Improve Their Credit Scores

• Recent information has more impact on the credit score. To improve the score:– Pay bills on time. – Once current on bills, stay current.– Keep balances low on unsecured

revolving debt.– Apply for and open new credit accounts

as needed.

• Pay off debt rather than move it “around.”

• Do not close unused credit cards as a strategy.

• If you have a new credit history, do not open too many new accounts.

How Consumers Can Improve Their Credit Scores (cont.)

• Make sure the information on credit report is accurate.

• Minimize the number of times creditors are given permission to check credit.

• Don’t try to quickly maneuver the credit score.

• Do not rely on so-called “credit repair” services. Fix errors at source of the data.

How Consumers Can Improve Their Credit Scores (cont.)

Credit Reports

• Three credit repositories:– Equifax.– Experian.– Trans Union.

• Three types of credit reports:– In-file credit report.– Tri-merge credit report.– Residential Mortgage Credit Report

(RMCR).

Reviewing Credit Reports

• Review borrower information:– Name.– Social Security number.

• Compare debts to application.• Review each trade line payment

history.• Are there any collections or public

records.

Reviewing Credit Reports (cont.)

• Pay attention to fraud alerts:– Social Security number alerts.– If employment information given, does

it agree with application?– If prior addresses given, are they in

agreement with application?

Reviewing Credit Reports (cont.)

• If debt not on credit report:– Written verification from creditor.– Verification of Mortgage (VOM).– Verification of Rent (VOR).– Twelve months of cancelled checks.

•ECOA Code.•Creditor.•Date reported.•Date opened.•High credit.•Type/Terms.•Balance

owing.•Amount past

due.•Months

reported.•Historical

status.•Remarks.

Reading the Trade Lines

Credit Scores

• Each repository has a scoring engine:– Equifax – Beacon Model.– Experian – Experian/Fair Isaac Model– Trans Union – Empirica Model.

• Fair, Isaac Company. • Scores range from 300 to 900.• Each repository weighs the same

elements.

Credit Scores (cont.)

• Credit score weights:– Payment History 35% of score– Amounts Owed 30% of score– Length of Credit 15% of score– New Credit 10% of score– Types of Credit 10% of score

Credit Scores (cont.)

• What each element reviews:– Payment History:

• Considers late payments, public records, number of accounts with no late payments.

– Outstanding Debt:• Considers amounts owed, type of accounts

with balances, amount of total line used.

Credit Scores (cont.)

– Length of Credit:• Considers how long credit used, average

age of all accounts, how long since account used.

– New Credit:• Considers number of new accounts, last

time new account opened or inquiry made.

– Types of Credit in Use:• The kinds of accounts in use and how many

of each.

Selecting the Credit Score

• Usually each repository reports a score on each borrower.

• Determine the score for each borrower:– If three scores per borrower, select the

middle numerical score for each borrower.– If two scores per borrower, select the

lower score of the two for each borrower.– Select the lower score between the two

borrowers as the selected score.

One Partner. Countless Advantages.®

Questions and

Answers

One Partner. Countless Advantages.®

How to Process A Conventional Loan

Verifying Employment

• Standard documentation:– Verification of Employment (VOE).– Mailed or faxed to employer.

• Alternative documentation:– Pay stubs.– W-2s for two years.– Verbal verification of employment.

Verifying Employment (cont.)

• Self-employed borrowers:– Two years’ personal tax returns.– Two years’ business returns.– Balance Sheet and Profit and Loss if

required by loan program.

Property Appraisal

• Appraisal states the property value: – Property will be the collateral for the

loan.

• Ordering the appraisal:– Appraisal fee collected at application.– Furnish appraiser copy of sales

contract.– Furnish appraiser contact name and

phone number for entry to house.

Property Appraisal (cont.)

• Appraisal:– Property address – legal description.– Describes subject site.– Gives zoning and flood information.– Confirms condition of the property.– Compares subject to like properties.– Determines value.

Understanding Ratios

• Manually underwritten file ratios:– 28% / 36% standard.– Check investor guidelines as may vary by

LTV, product, or occupancy type.

• Fannie Mae:– Benchmark: 36% Total debt to income ratio.– More emphasis on total debt to income ratio

than housing expense ratio.– Research shows total debt to income ratio

affects default likelihood.

Understanding Ratios (cont.)

• Freddie Mac:– Ratios of 28% / 36%– Debt to Housing Gap: 15 “points.”– Difference between the monthly debt-to-

income ratio and monthly housing expense.– Default increases the larger gap between

total debt to income and housing ratios.

• GSE ratios can be exceeded with strong compensating factors.

Decision Factors

• The four Cs of underwriting:– Character:

• Reviews borrower’s business record, credit and employment history.

• Shows the borrower’s willingness to pay obligations.

– Capacity:• Reviews the borrower’s income ability.• Shows ability to generate enough income to

repay the debt over a period of time.

Decision Factors (cont.)

• The four Cs of underwriting:– Capital:

• Reviews the borrower’s financial picture during loan application.

• Shows sufficient assets to close loan.

– Collateral:• Determines if the property value and the

actual property are sufficient collateral for loan.

Mortgage Insurance

• Protects lender from borrower default.

• Required on LTVs greater than 80.0%

• Mortgage insurance (MI) premium:– Included in monthly mortgage payment.– May be financed in loan amount.– May be lender paid.

Mortgage Insurance (cont.)

• Federal law states lenders must:– Disclose to borrower at closing and

annually their right to request MI cancellation.

– Cancels MI when loan balance reaches 78% of original loan balance.

• Borrower must contact lender regarding cancellation requirements.

One Partner. Countless Advantages.®

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Answers

One Partner. Countless Advantages.®

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