I haven’t posted anything related to mortgages in a while so this week I decided to talk about the credit scoring model. First and foremost, FICO is the Fair Issac Corporation model. It’s used exclusively by Experian. The are five main categories of information that the FICO score evaluates:

Credit Payment History: 35%
At 35% Credit Payment History weighs the most. While events such as a bankruptcy, foreclosure or tax liens will have the greatest negative impact on your score, multiple and/or recent late payments have a tremendous impact as well.

Credit Balances: 30%
What is your credit balance to your credit limit? The Outstanding Credit Balance ratio has the second highest weight on your credit score. High balances on your credit cards can be viewed as a red flag since it’s an indication that you may be overextended. If you have multiple credit cards, you may want to spread the wealth to keep the credit balances to credit limit ratio low.

Credit History: 15%
Credit History is a reflection the length of time that you’ve had accounts open. You’re rewarded for keeping long term debt. Older credit accounts that have been used more frequently will have more weight than those that are newly opened or used with less frequency.

Credit Inquiries: 10%
Opening a new credit account doesn’t harm your credit score dramatically especially after you make the first payment. However, credit inquiries can negatively impact your score. Generating many credit inquiries exudes that you are trying to secure a large amount of credit or you are being turned down by lenders and have to apply elsewhere.

Credit Types: 10%
This percentage of your FICO score is based on your mix of credit. Do you have a good mix of credit cards, retail accounts, installment loans, finance company accounts or mortgage loans? It looks at the whole picture and totals how much of each type of account that you have.

Whenever I speak to potential borrowers one of the questions I typically ask is “What’s your credit like?”. Most of responses I get are excellent, good, fair, poor. However, excellent, good, fair, and poor are meaningless in the mortgage world. The Fair Isaac (FICO) scoring algorithm is used to determine your ability to repay debt regardless of your gender, religion, race, creed, height, weight, etc. The highest score you can get is 850. The avergage score is around 680. Scores above 720 are considered excellent. Scores below 620 are considered poor.

To find out where you rank, you can get a free copy of your credit report now at www.annualcreditreport.com

I wanted to revisit Paying for Points. Recently I encountered savvy borrowers who understood the benefits of paying for points. When we discussed each option I presented, they understood that there was a difference between the rate I offered and the APR.

What is APR?

APR stands for “Annual Percentage Rate” and is the cost of credit expressed as an annual rate. APR is one of the most misunderstood numbers people come across when applying for a loan.

As consumer loans, and mortgage loans in particular have become more complicated, it became necessary to help standardize the ways lenders advertise and quote interest rates. APR was created to help people compare similar loans from different lenders and to explain the ultimate cost of credit. Quoting APR is required by Regulation Z of the Federal Truth-in-Lending Act.

Why is the APR higher than the interest rate?

Because you may be paying loan discount “points” and other “prepaid” finance charges at closing, the APR disclosed is often higher than the interest rate on your loan. This APR figure can be compared to the APR on other loan programs to help you compare the cost of credit for each type of loan.

How do I find the APR on my loan?

Once you have applied for a mortgage loan, the Federal Truth-in-Lending Disclosure Form (TIL) will be sent to you. If you have applied for more than one type of loan, you will receive a TIL for each loan type. At the top of the form, you’ll find your “APR.”

Revisiting our example from Paying for Points Part II, here are the rates and their corresponding APR’s

In 2004 Larry Brown finally hit the apex of his NBA coaching career when he guided the Detroit Pistons to the NBA Finals and won. This year, he almost replicated the feat when his Pistons made it again to the NBA Finals but lost. Yesterday, he was named head coach of the New York Knicks.

At $10 million per year, he’s going to be the highest paid coach in the NBA. Sorry Phil “Zen Master” Jackson but Larry is now numero uno. He’s going to need every penny as he relocates his family from the suburbs of Detroit to the suburbs of New York City.He’s planning on moving to Westchester County. He might end up living down the street from Bill and Hillary Clinton since they live in Westchester (Chappaqua) as well.

Chances are he’ll be getting an estate that will easily run him between $5 to $10 million. Forget the mortgage payment, the property taxes alone are astronomical!

Chances are he’ll be getting his mortgage from a professional, not some smooth talking idiot who talks about getting him the best rate and can beat his competitors rate. I also highly doubt he’ll shop around for the best rate cause his time is valuable.

His time is indeed valuable. He needs to coach a team that finished 33-49 last year with no real center and a point guard that has never won a playoff series. I wish Larry the best of luck in getting a home, in getting a mortgage, and in getting the Knicks to the NBA Championship!

Points come in two varieties, origination and discount points. Generally a “point” is a fee that the lender charges to buy down the interest rate and is equal to one percent of the loan amount. “Discount points” vary inversely with the rate quoted-that is, the lower the rate quoted, the higher the amount of points charged. Discount points are used to adjust the yield on the loan to the institution providing the money. Origination points, such as is common for FHA and VA loans, are generally charged by the lender to offset the lender costs of administering the transaction.

Does it make sense to pay the points? The answer is…it depends. There are many factors to consider. One of the primary items to review is the overall long term cost of a zero-point loan versus a loan with points. One easy way to determine the value of paying points is to determine how many months (payments) it will take to recoup the original expense. The math is easy. Simply, divide the cost of the points by the monthly savings to arrive at the number of months it will take for yourinvestment in points to pay for itself. Here is an easy example:

The example is a simple approach to compare the difference between a zero-point loan and a loan with points. However, there can be other factors to consider. Some consumers may try to calculate tax implications of the different amount of points and interest paid and the subsequent tax deductions. Other borrowers may consider the present ‘value’ of the dollars spent on points today, versus the future ‘value’ of the dollars if they were invested instead of being paid to the lender. A great majority of consumers will be able to determine the advantages or disadvantages of a zero-point loan by using the above scenario.

NO COST LOANS There is no free lunch, even in mortgage lending. Every real estate financing transaction has costs for processing the application, appraising the subject property, administering the transaction escrow, securing title insurance, etc. In a typical “no-cost loan” the lender agrees to pay all of the costs of the transaction for the borrower in exchange for the borrowerpaying a higher price for the loan. Depending on the individual borrower’s circumstance, this may or may not be a “good deal.”

You will make the right financial decisions today if you have a plan for your future. In other words, your mortgage professional can plan your mortgage around your goals and aspirations. If you plan to move or refinance your mortgage loan within the next five years you most likely should not pay points. If, however, you know you are going to be in this home for a long period of time, you can definitely save money by paying the points. Take a few minutes and think about where you are going to be in the next 3-5 years. The answers you come up with will help you make the right decision about paying points.

On a daily basis, I get asked Where are rates going?

Rates are at their lowest point historically in 40 years. If you apply standard logic, rates are bound to go up. I’m not an expert but even the experts don’t really know. All day long on CNBC they talk about mortgage rates, some experts say they’re going up, some experts say they are staying the same. Confusing!

By far the best indicator for mortgage rates is the 10 year bond, as the bond prices go up, the bond’s yield drops, and then rates drop.

Check out smartmoney, they post the yeild for a 10 year bond on their main page. If it’s red, expect rates to go down, if it’s green, expect rates to rise. Keep in mind when rates go up they take the elevator, when rates go down, they take the stairs.

Greetings! Thanks for visiting my blog! I was once a software developer starting with BASIC when I was a teenager to FORTRAN and COBOL and ending my career with JAVA. A few years ago I left IT for the brutally competitive world of home loans, financing, and mortgages. The purpose of my blog is to relay relevant loan information such as:

- rate trends

- new loan programs

- home buying strategies

- refinance strategies

- my unique perspective on life

Check back early and often.

Cheers!