S1EP38 – Everything You Need To Know About Credit – Part 1


How important is your credit score when it comes to buying a house and getting a mortgage? What is a good credit score? What’s the minimum credit score you need to qualify? What factors make up your credit score? In this episode, we take a deep dive into the world of credit and credit scores where we discuss the credit score model, the changes coming and how to maximize your credit to help you become The Educated HomeBuyer.

Connect with me 👇 Jeb Smith (huntington beach Realtor/orange county real estate) DRE 01407449 Coldwell Banker Realty ➡I N S T A G R A M ➳ https://www.instagram.com/jebsmith ➡Y O U T U B E ➳https://www.youtube.com/c/JebSmith

Connect with me 👇 Josh Lewis (Huntington Beach Certified Mortgage Expert) DRE 01209148 Buywise Mortgage M:714-916-5727 E: josh@buywisemortgage.com ➡I N S T A G R A M ➳ https://www.instagram.com/borrowsmartjosh ➡Y O U T U B E ➳https://www.youtube.com/c/buywiseborrowsmart

✅ – Want to get connected with us or to a local expert in your market, please reach out at http://www.theeducatedhomebuyer.com/expert

📩 – info@theeducatedhomebuyer.com

🙏 If you found any value today, please be sure to rate and review us. Follow us on social media. Thanks for listening.

Show Notes Below 👇:

[00:00:00] Jeb Smith, Huntington Beach Realtor: Today we are going to be talking about credit, credit scores, credit history, and how it affects your ability to qualify. We’re also gonna be talking about how it affects different types of loan programs, some things you can do to improve it, the changes that are coming with regards to credit scores. Josh, why don’t we just dive into it?

[00:00:19] Josh Lewis, Certified Mortgage Consultant: Absolutely tho those are the two conversations that I have with potential borrowers and say, Here’s where my credit is. Does it prevent me from borrowing or dictate which loan I can be approved for? And then secondarily but probably more importantly, cool, I can be approved. What does my credit score do in terms of an interest rate that I qualify for?

So we’re gonna go through that for the different types of loan programs, give you some ideas and some context for what a good credit score is. I think a lot of people have a misconception of what the distribution of credit scores looks like. We had in the early two thousands, the market had shifted down where if any of you.

Have seen the big short, you’ve saw Wall Street’s insatiable appetite for mortgage backed securities, and what that did to pushing credit scores down, we got to a point where the average credit score on a mortgage was in the lower 600s, 630-640, and now going on 10 years, we’ve been above 720 for that mid score.

So, Jeb, why don’t we kinda start the discussion there. Do, does the average American’s credit score look like? What does that distribution look like and where does that put you? Because most of us nowadays, whether it’s a credit card, Credit Karma, someone’s giving you a free credit score. Or if you don’t have that, you can go to free credit score.

Get it once a year and get your report and see what those scores look like. But Jeb, tell me how this jives with what you see and what you would expect. 20% of Americans have a score from 800 to 850. That would be the top. The next 25% are at 740 to 799. So what that tells us right there is 45%, nearly half of all Americans have a credit score, 740 or above.

In the people that I’ve talked to, most people think 700 and above is the threshold for a good score. But what we’ll see here, the next quintile here, breaking it up into 20 percentage groups, roughly 670 to 739 is another 21%. Then we’ve. 18% at 580 to 669 and 16% down at 300 to 579, and those are incredibly rare.

In the last few months, I have seen one in the 400s. It’s pretty difficult to get a score below 500. 

[00:02:20] Jeb Smith, Huntington Beach Realtor: You gotta do a lot of work to get your credit score below 500. I, you when you say that, I’m actually a bit surprised that there’s that many people, 20% above an 800 just, in, in being in your shoes, for 10 plus years and seeing a lot of credit reports and just credit history in general.

I never saw a lot of above 800 credit scores. I mean, they came here and there. I think the highest I’ve ever seen is like an 819. I’ve never seen anything higher than that. So knowing that they go to 850 is is surprising. I know that, but to see anyone actually come away with an 850, I think I would be, really surprised to see that.

And I think I’m also surprised to see, 75% of people have a score higher than 670. I would almost feel like you would have it being split more so than anything else. You know, half people above say a 650 and then half below a 650 just because, credit, a lot of people don’t understand credit and it’s really easy to miss a payment here and there over the course of, a year or months or whatever it is, and, At the end of the day, that ends up affecting your credit score.

[00:03:18] Josh Lewis, Certified Mortgage Consultant: The average credit score is 716. So surprised by that. Too surprised by that. So think about that for a second. When someone tells you, again, I think that everyone’s like me and we talk about people’s credit scores as part of their job, but when very early in the conversation, I’m gonna ask a borrower, Have you seen your credit score recently?

Do you know what your middle credit score might look like? And I will always hear some version of, Hey, my credit’s pretty good. It’s a little over 700 and what we’re hearing here is 716 puts you at average, which most people think a 700 credit score would be a good score. 

[00:03:48] Jeb Smith, Huntington Beach Realtor: Now, you just said something Josh said, I think is important to note.

You said your middle credit score. So when you say middle credit score, what are you talking about? Because a lot of people don’t understand that, you have three, three scores when you, when your credit’s pulled by a mortgage lender and it’s not the average. So what is the. 

[00:04:05] Josh Lewis, Certified Mortgage Consultant: For mortgage purposes, we pull a three bureau credit report.

So there are three major credit bureaus in the United States that gather and aggregate your information. TransUnion, Experian, and Equifax. So we have to pull all three. It’s okay if for some reason you don’t have one or even two of those, but. 90% of clients are going to have all three scores. Probably 98% of clients are gonna have all three scores.

And when we have three, the one that we’re going to use for our scoring purposes is the middle or the median of those three. If you only have two, we’re gonna use the lower. And if you only have one, we’re gonna use that score. But we’re still gonna need to get an automated approval, which gets more difficult because people that don’t have credit scores generally don’t have them because they don’t have much credit history.

I had a lady here recently. Retiree doesn’t use credit. Her husband had three scores. She had one and we couldn’t get an automated approval. We had to add her as an authorized user on a few of his accounts to, to get it there. But that’s [00:05:00] what we’re looking at is the middle score. We’ll go into this, I was actually gonna save it for later, but it kind of fits pretty good in this conversation.

We had a change within the last year that there is a situation where for eligibility purposes, but not for pricing Actually, why don’t we talk, Jeb, just real quickly, what are the minimum scores for each different type of loan? It varies. We’ve talked about what people are likely to have, but why don’t we pencil that out and say, what does it look like to qualify for each type of individual loan?

[00:05:27] Jeb Smith, Huntington Beach Realtor: I like that, but I also like the idea of telling people what goes into your credit score. Like what creates that score? So that we have a basis so we can go either direction, whatever you think is a better flow for, creating educated home buyers. If you. 

[00:05:39] Josh Lewis, Certified Mortgage Consultant: Let’s set a baseline for each type of loan program, what you want to be eligible for.

Number one, am I eligible? Can I qualify for that loan? And then number two, what’s going to get me the best pricing? So for conventional loans that are underwritten and sold to Fannie Mae, Freddie Mac, you have a minimum credit score of 620. To get the best terms you want to be above 740.

They don’t have a tier above that. So in terms of their pricing matrix, anyone 740 and above. So we’ve got what 45% of Americans are gonna fall into that group are gonna get the absolute best pricing. To get good pricing, you wanna at least be above 680. I actually pulled up the numbers here.

So we say the minimum is 620 to get decent scores . Pricing is 680. To get the best is 740. If you are putting 5% down, the difference between a 740 credit score and a 620 credit score is. Three points in pricing. Now, if someone’s putting 5% down, they’re not gonna pay three points to get the same rate as the person with a 740 credit score.

What they’re gonna do is they’re gonna take a higher interest rate. So in real terms, that’s about three quarters of a percent or more in interest rate between a 620 and a 740. So why do we say 680 is important? At 680, you’re paying about one point more than the person with a 740 credit score, or about a quarter percent in interest, so you can still get a good and reasonable interest rate when you have a 680.

When we go all the way down to a 620, you’re eligible. You may get an automated approval, you may get a manual approval, but the terms are gonna be much worse. The other thing to keep in mind with private mortgage insurance that goes along, Fannie Mae and Freddie Mac loans that also uses a credit scoring component.

And on that, a 740 doesn’t get you the lowest mortgage insurance rate. It’s gonna keep improving all the way up to about that 820 level. And the reason why we start talking that 680 being important, you’re gonna pay about a quarter percent higher in interest rate, but depending on how much you’re putting down on a conventional loan, that’s gonna add anywhere from a quarter to three quarters to the mortgage insurance.

That threshold right there under 700 is where you see a lot of people needing to go to FHA financing because the payment is so much more on a conventional loan. So that gives us a natural transition to say, Okay, what does an FHA loan look like? 

[00:07:59] Jeb Smith, Huntington Beach Realtor: Before you dive into that though, Josh, you mentioned mortgage insurance, so something important to note depending on where you’ve found us in the podcast and what you know about loans, whenever you put less than 20% down in buying a house, you’re going to have some form of mortgage insurance, and so that’s what Josh was referring to when he is talking about private mortgage insurance. But we can continue with FHA. 

[00:08:18] Josh Lewis, Certified Mortgage Consultant: Absolutely. As we switch over and say, Okay, I have a 660 credit score, you’re likely gonna have a loan officer say, Hey, FHA is probably the better option for you. So now FHA has a much lower credit threshold. So for an automated approval with your normal three and a half percent down FHA, you have to have a 580 credit score.

You can go all the way down to 500, but for the most, 580, although it’s not the floor, it acts as the floor. So what do we look at there? The difference between having a 680, which will generally get you the best tier. And just so you know Fannie Mae and Freddie Mac actually have this in writing.

There’s a pricing matrix that says, Hey, this score is going to pay this much worse. FHA and VA don’t have that. But the lenders and investors buying the loans, they do say, We’ll pay this much for this credit score. We’ll pay less for this credit score. So it does impact, and for the most part, 680 ends up being an important score.

If you drop down to 640, and sometimes the lender will be at 620, but if you drop down to 640, you’re gonna pay about an eighth to a quarter percent more in interest rate. So it’s not a huge amount, but it is a chunk there. Now we said we can go all the way down to a 580. That’s gonna be anywhere from five eighths to three quarters of a percent higher in interest rates.

So it gets pretty punitive there. VA also very similar to FHA, the best terms are gonna be 680 and above. Sometimes a lender will pay or offer better pricing for a 720 or a 740, but generally 680 will get you the best terms. 640 will get you and above. We’ll get you good terms.

And if we go below 640, we have two pieces. You’re gonna pay that premium, five eights, three quarters percent higher in interest rate, but it also gets much less likely that you’re gonna get an automated approval. [00:10:00] Now, FHA and VA loans are very good at doing manual underwriting. Meaning instead of your data going through the computer and it’s spitting out an approval, a person has to review it.

Now the problem with that is that underwriting is much more restrictive, Lower debt to income ratios, we have to have other compensating factors. You can probably see at this point a minimum goal for someone wanting to buy a home should be 680. If you can’t get to 680 get to 640. So we can still likely get you an automated approval in good terms.

And if you’re looking at a conventional loan, you wanna be 740 and above. So that current kind of sets the threshold for where are we trying to get, what is optimal for a borrower as we transition to what are the things that a borrower can do to maximize their score. 

[00:10:42] Jeb Smith, Huntington Beach Realtor: I ran some numbers, Josh, on, on doing something similar. I did a video, and which is better for the buyer, a higher down payment or improving your credit score. If you have a 650 to say a seven, an 800 credit score, you’re talking a significant difference in the rate. I mean, half a percent, three quarters percent in some cases, between a 650 and an 800 depending on the loan program.

When I ran the numbers, it was the difference in payment was huge in just that little piece alone. And raising your credit score is typically a lot easier than coming up with a lot more money for a down payment in many cases. But let’s talk about what actually makes up that credit score, because I think this is where people.

Can work on things. The, there, there are things that you can do as a borrower to improve these. There are things that you can do as, or a borrower, as a homeowner, as a potential homeowner that you can do to improve it. Things that you can do to manipulate it in some ways. Get your score up. And at the end of the day, a any positive changes in that score are ultimately going to lead a better interest rate and in turn a lower monthly payment. 

[00:11:51] Josh Lewis, Certified Mortgage Consultant: Absolutely. So I like to tell people that you can absolutely improve your credit scores. The only thing your credit score is a snapshot of a moment in time. If I pull Jeb’s credit right now, that tells me what it looks like today. If he misses a payment tomorrow, That gets reported, it’s gonna be much worse if he pays off a loan.

It’s a revolving credit card. It’s likely to get better. So the two things that are required to improve your credit score are time and or money. So let’s go through the five elements that make up your credit score and what portion of your credit score. Then we’re gonna talk about what we can do to manipulate those in your favor to get as highest score as possible.

The first. Is your payment history, and that accounts for 35% of your score. Now, this is one that really to improve takes time because this is factual. If I missed a payment six months ago, it’s going to be there for seven years. Public records will remain for 10 years, but your payment history is on there for seven years.

I have an interesting one. I completely spaced it back in 2015 and I missed a payment. I’ve never missed a payment in my life. It was the one payment. And you think, okay, well that was almost eight years ago. Until July of last year, whenever I would look at my score, it gives you the four factors. One of those factors was payment history, and when that fell off last July, the score bumped 40 points.

It went from the high 700s well into the 800s, and that was the only thing that changed from one month to the very next. So, your payment history is very important. The most heavily weighted is your recent history. So, like my situation seven years ago, I had a late payment one 30 day late. I still had a high 700 credit score, but when that fell off, it was 40 points higher.

So if you have a credit late, you legitimately missed a late payment in the last 12 months. It’s gonna have a fairly big impact on your credit score. I’ve seen a husband and wife, or the husband has a seven 40 credit score. Wife has virtually the same credit, but she has one store card that she accidentally screwed up and missed a payment on.

And if it was two to three months ago, that can be a 70 or 80 point hit to your scores. So it’s looking at all of these things, not in a vacuum, but combining them together. But that, is the easiest one to understand. It’s, have I made my payments on time? Have I ever had any late payments?

Was it more than 30 days late? Was it 60 days? Was it 90 days? The scoring model is looking at that most heavily. That’s 35%. 

[00:14:19] Jeb Smith, Huntington Beach Realtor: And I think Josh also important to note when we talk about being. You know there’s a due date, right? So my, my credit cards, two of ’em American Expresses, are both due on the 10th of every month.

If I make them on the 11th, that’s not considered late. It’s 30 days late. So that means, you still have a buffer there before you actually get to 30 days to make that payment before it actually reflects on your credit report. So, being late here and there, there, there’s actually a grace period, a 29 grace period after 29 day grace period after your payments.

Before it reflects on your credit report. Now I wouldn’t, recommend going out there and pushing it to that. But the reality is you can still be late on some of this stuff without it [00:15:00] actually being quote unquote late. When it comes to credit. 

[00:15:03] Josh Lewis, Certified Mortgage Consultant: Absolutely. So factor number two is the amount that is owed and it’s looking less specifically at total dollar amount.

Now imagine if you’re Elon Musk, you might have a credit card with $150,000 balance on it at the end of the month. For the typical person, that would be a bad thing, but if he has a $500,000 limit, Not such a big deal. So what it’s looking at is the credit utilization ratio. How much credit do you have available to you?

How much have you used? So let’s say you have three cards with $5,000 limits on them. So you have $15,000 total available and you’ve used. $3,000, that puts you at a 20% utilization ratio. And the scoring model’s gonna look at that going, that’s fairly reasonable usage of credit, and we’ll go a little bit deeper on that in a minute.

Whereas if you owe $16,000 on the three cards with a $15,000 limit, it’s looking at this and going, Hey, that’s a problem. This person is going above and beyond the limits of what the creditors have agreed to loan them. So this is. Favorite because this one doesn’t have to get resolved with time. It can get resolved with money.

So if I have a client who has three maxed credit cards and they say, Hey, we’re gonna put 25% down, I tell ’em, no, we’re not gonna put 25% down. We’ll put 5% down, we’re gonna pay those cards down and do a rapid recore, which we’ll get into in a little bit. So the last three factors are much smaller percentages and a little bit harder to manipulate, especially in the short term credit history.

How long have you had your credit? So you said, Jeb, I didn’t see a lot of credit scores over 800. I still very clearly remember the first 800 credit score I saw. It was a husband and wife. They were 70 something years old. They had had credit for almost 50 years and had never missed a payment. So the length that you’ve had credit, all that does is it tells the model that we can watch for 50 years and see how these people handle their.

If you’re 22 years old and you got your first credit card when you were 19, we only have three years of knowing how in a good and bad economy, different times, different phases of your life, how you’re going to handle that. So depending on your age, there’s not a heck of a lot that you can do about the length of your credit history that accounts for 15% of your credit score.

Credit mix, the types of accounts you have. Auto loans, mortgages, student loans, credit card, other installment debt that accounts for about 10%. So in the short run you can change this. Let’s say you only had one credit card. Well, I could go out and get a store card. I could ask for another credit card, but.

It’s going to give you an inquiry. It’s going to have a new account, so the length of time that your account has been established. So in a short run, it’s gonna be a negative over 6, 12, 24 months. Once the model has had time to see how you pay that, it will be a positive, but, When we’re talking about using time and money to improve your credit scores, that’s not a great one to go after.

The last one, this is the one that everyone’s aware of, is new credit and inquiries. So we talked about if I opened up a new credit card, again, the model doesn’t know, there’s some uncertainty there. Hey, they just went and got new credit. Does that mean they’re in trouble and needed money or does it just mean they had great offer for 20% off from the store That.

Inquiries are important, but it’s also important to note what the model is looking at. If you go to 10 different stores one weekend and attempt to open up store cards or 10 different banks and attempt to open credit cards, the model is gonna look at that and go, Whoa, this person’s asking everyone to loan them money.

They must need money. That’s a bad. Now if you go to four different mortgage lenders, the model is instructed by the CFPB that you have a 45 day window to have as many mortgage inquiries pulled as you want. That way you’re able to compare offers with full information. The lender can see your credit report, give you an actual and factual preapproval with terms that are available that day based off of your credit record, with it only being treated as one inquiry.

And auto loans and student loans fall under the same category. So any of those, you don’t need to panic about having more than one inquiry. You just need to make sure you keep them within a 45 day window. And I would tell people do it within two to four weeks. Let’s not push it out to 45 days and run the risk of getting an additional inquiry. So with that, Jeb, why don’t we transition to what you can do to maximize the credit score.

[00:19:14] Jeb Smith, Huntington Beach Realtor: Well, I think it’s also important to note what’s not on your credit report, right? So your cell phone bill your rent, as of right now, the scoring model doesn’t take your rent into account, small bills that, that you pay, your utility bills. They’re not reporting on your credit report. Like Josh said, it’s revolving debt, it’s installment debt. That’s primarily what.

What gets reported. So oftentimes, people are, when they talk about debt to income ratio and qualify qualifying for homes they’re saying well, you’re not counting all this other debt I have. Well, the lender doesn’t take that debt into consideration. They’re only using what actually reports on your credit report in addition to, if you’re receiving child support or paying child support, alimony, that sort of thing.

That stuff typically isn’t on your credit report. Unless. Behind on it. At which point it might [00:20:00] show up, but that’s what they’re using when they’re looking at credit. But Josh, yeah I think let’s maximizing your credit score, right? I think that’s why a lot of people are probably here.

How do I get a higher credit score? How do I get a better credit score? What do I need to do to improve it? 

[00:20:13] Josh Lewis, Certified Mortgage Consultant: Let’s use what you just said. The point that you just brought up. The things that don’t report. You’ve probably seen commercials for the last couple years, Experian has been pushing Experian Boost.

Report your credit card your credit card, your cell phone bill your auto insurance, your utilities, and we can add those to your credit record. And if you’re paying those on time, it will boost your score. It does work. But it’s only one bureau we talked about. You have three bureaus, TransUnion and Equifax don’t have a similar thing to Experian boost, and as a result, you’re only gonna boost the one score.

Now, if Experian happens to be your mid score and you get 12 or 15 points of boost there, that can be very helpful if Experian is already your highest score or if it’s your lowest score and it doesn’t become your middle score, no real benefit from there. Furthermore, if you’re looking at getting a jumbo loan, some of the private lenders, non QM loans, jumbo loans, they will make you remove Experian boost cuz they feel like you’re artificially manipulating your score.

And you can see because the items that you’re adding there will say self-reported on your credit report. Even though it is pulling it from bank statements showing that you’ve made those payments on time. So it’s an interesting thing. I don’t generally see anything bad about it. I wouldn’t tell anyone not to do it.

I also wouldn’t tell anyone to hold out high hopes. Is he gonna change the terms of their loan very much. So, in going through this, let’s just basically go back through what of those factors can we change, Jeb? The most important thing is pay your bills on time. That’s 35% of your score is your payment history.

Don’t have any lates, especially in the last 12 to 24 months. Once you’re past 24 months, your credit score will have healed from a missed payment as long as there wasn’t a long pattern of missed payments. If you miss a payment, it’s 30 days late, don’t let it go 60 or 90 or 180 days late and don’t let it go to collection status.

The further it goes, the bigger that hit is to your score. These are all statuses that are reported to the bureau and their algorithm can see and read those things. So hopefully if you’ve missed a payment, it was an oversight. Sometimes if you contact the creditor, Give them a great sob story. This doesn’t happen very often, but occasionally we’ll have clients contact a creditor and they have one missed payment ever in their life, and they’re able to get it reversed if the creditor decides to have grace.

But for the most part, it’s simple. Make your payments on time. If you miss a payment, don’t let it go more than 30 days late and bring them current as quickly as possible. I have people reach out to me and they want to get a loan and they’re currently 60 days late on a credit card. It’s gonna bang their scores pretty bad and make it hard for them to qualify.

One of the things that we’ve seen, as soon as that credit card is brought current, it will improve rather markedly. It’s gonna be much worse than it was before the late, but as soon as it’s brought current, it improves. As soon as we get to 12 months, it improves. As soon as we get to 24 months, it improves.

I was gonna ask you about mortgage payments. So back in the day, having a 30 day mortgage late on your credit was, basically killed your ability to be able to buy a home. Is that still the case? If I’m currently selling my house, buying another one, I’ve got a 30 day late, is that going to affect me like a credit card or am I not gonna be able to get a mortgage at all because of that late?

Most loan programs will allow one times 30 in the last 12 months. Jumbo loans, for the most part, will not allow that. What’s really important is your terms are gonna be a lot worse. A mortgage late will be treated more harshly by the bureaus in the scoring than a credit card late, so you’re already gonna take a hit to that credit.

Now, once we get to two 30 day lates or a 60 day, Now all these lenders are gonna push that out further before you are eligible. So now you’re talking about some type of non QM loan with much, much worse terms than what is available in the market today. So it’s a really good point and it is very important to not have a mortgage late.

And what we see with most people is the. They will focus heavily on getting their mortgage paid on time, their home equity line of credit, paid on time, because that’s a secured debt. It’s secured by their home. So we see a lot more lates on revolving debt, installment debt, student loans that type of stuff before we see on a mortgage because it is important to not have any mortgage late, although it’s not a complete killer.

So Jeb, we talked about that credit utilization. This one is fairly easy. If you’re getting hits to your score because you’re using too high of a percentage of your available credit, then we wanna bring those down as much as possible so that the limiting factor is do you have enough money for your down payment and closing costs and still some money left over to pay these down to optimize that credit score.

[00:24:41] Jeb Smith, Huntington Beach Realtor: Well, I think credit utilization is probably, you said the percentages and how they affect your score. But I think this is probably the most important piece of what we’re going to talk about in credit, because it can be not manipulated, but it can be changed in some way.

If you have some money, you can change it and there’s some ways that you can call your credit [00:25:00] company and change it and it can really impact your score. But it’s a big topic and there’s a lot that goes into it. So Josh, why don’t we cut it right there? Save that for part two, and in today’s episode, helping people understand credit, but where, we’ll take part two is actually, the ability to work on some of these things to help improve your score.

So tune in next week where we actually talk about part two of credit and helping you guys become the educated home buyer.

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