Onions are not the only thing with Layers!

I was sitting on my couch the other day watching one of the most infamous movies of all time with my children. The movie I am certain that many of you remember. During the movie there is a point when they talk about how “Onions have layers” and it got me thinking. Yes, that movie was Shrek and no this is not a pitch for the upcoming Shrek 4.

Like onions, all mortgage loans have layers. The layers are risk layers. Every file that we touch or work on is evaluated by the amount of risk to the investor. Risk is evaluated on several different ways. An underwriter has to be comfortable with the level of risk in order to approve the file. These layers can be described the following way: 1) Credit 2) Collateral 3) Capacity and 4) Compensating Factors.

Credit – Credit is more than a score. The score does make up the first level of assessment. If you do not have a score that meets the minimum requirement for the program you are done before you begin. However, what if you do have a score that is high enough to qualify for the loan program. Does that mean it is a done deal at that point? Credit has several components that we must go over to make sure that a consumer not only meets the requirement for score but credit as well. Some of these factors are:

• # of trade lines open and rating current – A trade line is an open account such as a credit card, and auto loan, a mortgage note, and installment debt or even a lease. These trade lines must remain open and most be rated to the current date. Some people have old credit cards that they never actively closed that have not reported in months. This shows the lender that you have the ability to open and maintain credit and when you have done so for several different types of credit it will help establish a solid score. They do go hand and hand. However if you have a 700 score and only one open trade line that is a small credit card open for 5 months this will not qualify. Although the score is high there has been little time for you to make a mistake and the low limit is a low risk for the credit card company. This would be insufficient credit.
• Several Open Collections – FHA specifically looks at the last twelve months of credit to see how you are doing now. There are cases that the scores are qualifying scores but a client has many open collections for semi large amounts. If this is not in the last twelve months the underwriter might require them to be paid especially anything over $1000 or so. If they are in the last twelve months and there is more than one you most likely will not qualify for the loan. If it is only one then you will have to write a suitable explanation and it will be left to the underwriters judgment. The only exception to this rule is Medical collections.
• Open Tax Liens or Judgments – Any of these items will have to be paid no matter what. They will also be further evaluated to see when they occurred what it is and why. Remember they are trying to see if there is any recurring behavior patterns of unpaid debts without explanations that make sense or situations you could not have predicted.

Collateral – is based on how much you are putting down on the property you are buying or the amount of equity you have in your current home. The larger the down payment the lower the risk. Anything less than 20% down requires Mortgage Insurance. Mortgage Insurance is designed to cover the investor on their losses in the even that the consumer forecloses. FHA is a Government insured loan and is designed to have a limited down payment so generally the collateral portion for FHA borrowers is usually not considered a strength of the file as a whole.

Capacity – This is the consumers ability to repay the debt. This is largely based on your debt to income ratio. However, capacity can be broken down further and commonly is:

• Time on the Job – If you are in a new industry where you get tips, overtime, bonus, commission or any other special compensation that you did not receive at your previous job they may not include this income. This could have a dramatic impact on the qualifications.
• Work History – I have had situations where the borrower had many jobs and this spooked the investor. I had to make up for spotty job history but accenting the positive factors of the loan.
• Self Employed Income Decreasing Year over Year – many loan officers take a two year average and that is the way that we are taught if and only if the income is steady and or increasing. In the event the income is decreasing year over year we use the current year only and we must make sure that the decline is not severe.

There are other items on capacity that we may look at in the layering of the risk but for time and length purposes that is all that we will discuss here.

Compensating Factors -Any factors that decrease the layers or levels of risk in the file. Some compensating factors may include but are not limited to:

• Assets
• 401K
  
• Long time on same job
• Reserves after down payment (not an FHA Requirement but considered a compensating factor)
• Low Debt to Income
• own funds to close not gift

The following Illustration is one that I have always used to give myself a visual of all the information above. Then I would rate each section 1-10 and determine how to present the strengths and minimize the exposure of the weaknesses.

Although overly simplified the graph shows that Credit, Collateral and Capacity are the focal points or base of the triangle. If any one of them are not very strong it is up to the supporting arms or Compensating factors to make up the difference. In order to do so the compensating factors have to make sense and be supportive to the overall structure of the file.

Ultimately the layers of risk will make or break your file. The goal of a loan officer should be to package the file in the best manner possible to make sure the underwriter sees why this is a good file. If someone has a high debt to income (Capacity) then it is essential that they are strong in credit and collateral and it is a bonus if they have compensating factors such as reserves. When borrowers want to do down payment assistance programs they are adding layers to the file. When you increase the layers or levels of risk you create a greater chance for error or decline. It is imperative that as you increase the risk you have supporting compensating factors that help to justify the risk an investor may take on you. As a consumer you can work toward this. Set yourself up for success. Decrease the layers that your file has and maximize your three C’s. This will help you to get a loan in today’s economy.

In conclusion, it is all about risk or layers. You want to give as many reasons to the investor to buy your loan as you can. I understand that it is hard to fire on all cylinders all the time and that is why Compensating factors play a huge roll. If you know that you have lower credit, don’t make a ton of money, and have limited down payment then you have to understand that you may be asked for several items. If you want to ask for down payment assistance you have to take a step back and be the investor. The question is why do I want to give my money to this person? Our job is to assist you in answering that question for the investor.

As always thank you for reading.

How is my Credit Rated? Part 2

Michelle Luker is back in the second part of a five part series regarding “how your credit is rated.” In part 1, Michelle explored how delinquency makes up 35% of your score. Today Michelle touches upon Debt Ratio which makes up the next 30% of your score.

30% of the credit score is derived from your revolving balances carried on accounts as they pertain to your debt utilization ratio.

Revolving credit cards make up a very significant portion of what ultimately determines your credit score. Your total revolving credit utilization ratio is calculated as follows: Divide your Total Open Revolving Credit Card Debt into your Total Open Revolving Credit Card Limits gives you your Credit Card Utilization Ratio.

Example: $15,000 of open credit balances divided into $75,000 of available credit card limits = 20% Credit Card Utilization Ratio (debt ratio for short).

The closer to zero you’re Credit Card Utilization Ratio is, the better your credit score.

Having a 0% debt ratio is ideal, so you want to keep your credit card balances as low as possible to maximize your credit score. If you are able to do so, you should pay off or pay down your credit balances to enhance our score.

Another step you can take to improve your credit scores is to lower your debt ratio by raising your current credit limits. Caution: You need to approach this matter with care. Call and ask each credit card company if they will crease your card limit based on a review of your payment history with them only. INSIST that you do not want them to pull your credit report and thereby create an inquiry that will damage your score. Some creditors will do this, some will not. I do not suggest letting them pull your credit if you plan to make a credit purchase in the next six (6) months since the inquiry will decrease your credit score.

Now you know that the most important factor in determining your credit score is based on the handling of your debt obligations

Whether you pay your creditor on-time is 35% of the score.

You also know that the second most important factor in determining your credit score is determined by the amount of debt you carry as it pertains to your revolving debt ratio.

Revolving account debt ratio is 30% of the score.

Contact Michelle Directly to see what steps you may take in bringing your score up to the highest levels.

Office: 916-652-9637

Cell: 916-316-0247

Fax: 916-644-6626

Capital Credit Source, Inc.

4804 Granite Drive, Suite F-3261

Rocklin, CA 95677

How is my Credit Rated Part 1?

Michelle Luker is back again at California Home Strategies to continue a series on understanding how our credit score is derived. This is Part one in a five part series that we will be rolling out. If you have any questions regarding your credit contact myself or Michelle Directly.

At Capital Credit Source, we feel that educating people on credit scoring is extremely important to their financial well-being. I wanted to take this opportunity to explain the credit scoring system to you since I feel credit scores are much more important than most people realize. On average, even a 10 point increase in your credit score will save you in excess of $100,000 over the life of a $250,000 30-year fixed loan.

Although seemingly complex and often confusing, your credit score is essentially based on five key factors, the first and most important being payment history.

35% of the score is based on how you handle your debt obligations

- Pay all bills on time and try to avoid getting a tax lien or a judgment entered against you because those also affect your payment history in a negative way.

- Please note that paying a past due balance on a collection or charged-off account does NOT increase your credit score and may even have the opposite effect more times than not. I do no suggest paying these types of accounts when you are planning to apply for a home loan in the next six (6) months. Please let me clarify that I am not suggesting that you not pay these accounts, but that you consider waiting until after the loan closes to pay them since it can reduce your score and hurt your chances of getting loan approval. However, since not paying them can lead to a lawsuit being filed or the debt being sold to several collection agencies in the future – both of which will damage your credit even more in the long run – one excellent solution would be to negotiate to pay or settle these account either concurrent with the loan closing or shortly after. An alternative would be to settle these types of accounts for deletion with payment if you are able to get the creditor to agree to do so.

Michelle Luker

Office: 916-652-9637

Cell: 916-316-0247

Fax: 916-644-6626

Capital Credit Source, Inc.

4804 Granite Drive, Suite F-3261

Rocklin, CA 95677

http://www.capitalcreditsource.com

My Credit Stinks!! What can I do?

I am a firm believer in credit management. The way that we are able to manage out credit will have a direct impact on the overall quality of the lives we lead. Credit can affect getting a job, mortgage, car, or the ring that you need to propose. This is why I am excited to announce that Michelle Luker of Capital Credit Source a “Certified Credit Expert” has agreed to do a series on Credit. So as part one to the series we have decided to do a brief introductory post:

“Understanding Credit and What it Means”

When you apply for Credit, lenders look at your FICO scores. FICO scores help lenders determine risk, and can have an effect on your ability to borrow as well as the rates or fees that you will pay. There are three credit bureaus: Experian, Transunion, and Equifax. Each of the credit bureaus calculate their own FICO score.

The FICO score gives lenders a prediction of the likeliness that an individual will pay 90 days late in the next two years. A high credit score would tell lenders it is less likely that you will pay 90 days late in the next two years. The lower the score the greater the chance.

For your FICO scores to be calculated you must have at least one account reporting that has been open for the last six months. There also must be one account that has been updated in the last six months. As your credit changes so will your credit score.

The credit bureaus take a snapshot of your credit profile at the moment that your credit is pulled. The scores are then determined by the data that is reporting at that given moment in time. Items that you have paid on that have not reported yet will not reflect in the score that you have received. You must also keep in mind that not all creditors report to all three bureaus. The information in the report for each bureau may vary slightly and in some cases can be dramatically different. If one bureau reports a collection and others did not that bureau can be significantly less.

As this is just the start of the series on Credit I encourage you to stay tuned. We will go in depth on the different measures of credit and how each piece of the pie can be monitored and maintained.

As Always thank you for reading.

Michelle Luker can be reached at www.capitalcreditsource.com or by email at info@capitalcreditsource.com