Credit

In the VA loan qualification process, credit scores are very important. Here is what you need to know about credit scores and how they affect your VA loan eligibility.

There are 3 major credit bureaus:  Experian, Equifax and Transunion.  Each of them uses a proprietary system to determine credit scores.  The mathematical range for a credit score goes from a low of 350 to a high of 850.

Generally speaking, there are five items that are considered when generating a credit score.  Listed below are the five times approximate weights of each category for establishing the credit score.

1) Payment History  (35%)

2)  Outstanding Balance (30%)

3)  Credit Mix  (15%)

4) Credit History (10%)

5) Inquiries (10%)


Payment History (35%): As you can see, this is the most important category for determining your credit score. Being late on a payment by more than 30 days is by far the most damaging thing you can do to your credit score.  Your score can go down by 100 points, virtually overnight, if you are late on your mortgage payment. Obviously, this is something you should avoid at all costs.


Outstanding Balances (30%): This is perhaps the most harmful category when it comes to your credit score.  Ignorance of its impact can cost you a lot of money over time. For example, let’s say you have a credit card with a maximum limit of $10,000.  Your current balance on it is $8,000 or at 80% of the limit.  Chances are that you feel safe, because you have left yourself a cushion of $2,000 on your card.  You might think this is a sufficient buffer. However, when your outstanding balance is over 50% of your credit limit, every month that that the balance remains over the 50% mark, your credit score will go down.

Additionally, if the high balance is on several different credit cards, then the rate of decline on your credit score accelerates. This can quickly spiral, since credit card companies can use the lower scores as an excuse to increase your interest rates. If your credit score dips below certain benchmarks, you will have trouble getting financing for anything from a car to a mortgage.

Real Life Example: A veteran family we were working with had a balance of $20,000 on a card with a $50,000 limit.  At the height of the financial crisis in 2009, they were informed that their limit was being reduced to $25,000 from $50,000.  Suddenly their outstanding balance went from 40% to 80% of the credit limit.  The next month, they got a letter from the credit card company informing them that their interest rate was being raised from 9% to 18%.

This is an extreme example, but things like this do happen to veterans (and many other people), and they can have a dramatic effect on your ability to qualify for a home loan. For this reason, it is important to pay close attention to your outstanding balances and pay them down as quickly as possible.


Credit Mix (15%): Your credit score is maintained primarily on the basis of the activity on your accounts or “tradelines.”  It is recommended that you have the following mix when it comes to credit:

Mortgages:  1 or 2

Installments:  1 or 2

Revolving/Credit Cards:  2 or 3

At a minimum, you need to have three open trade lines and as a maximum you should have no more than seven.  For VA mortgages, it is required that you have at least three open trade lines.

Credit History (10%): This category is based on what has happened to your various trade lines over time.  The most recent 12 months are always given the highest importance. This is good news. It means that, no matter what has happened to your credit ratings in the past, if you start taking corrective action, your credit scores will eventually improve.

Inquiries (10%): People are often concerned about the effect of inquiries on their credit.  The regulations now state that, within a 2-week period, if inquiries are made regarding the same item, they count as just one inquiry.

Real Life Example: Let’s say you are buying a new car, and you visit ten dealerships. Each of them runs a credit inquiry.  For the purpose of your credit score, all of these inquiries will be counted as 1, rather than 10, as long as they take place within two weeks of one another.


Questions?

Should you have any questions, please do not hesitate to contact Ashok Ghildyal, VA Mortgage Specialist, by phone at 866-993-6379 x250 or via email at aghildyal@primelending.com.

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