I make my payments on time. Why do I have a low credit score?

By
Mortgage and Lending with Ascent Home Loans

 

This question is asked often when I have people apply for a new mortgage and with good reason. You might believe that if your payments were made on time that should give you at minimum, a good credt score.

Not Always True!

 

Credit scores are composed of multiple pictures of your financial health and then rated on your "credit report", while making payments on time is VERY IMPORTANT, these other factors can improve or worsen your scores as well. Read on.....

 

There are several reasons a credit score may be low even if the payments are on time, but I will write about the most common cause that I have seen by doing a comparison of 2 families.

Example:

 

Client A: Has a 150K mortgage that has been paid on time since the home was purchased 4 years ago.   

An Automobile payment of 260.00 per month paid on time since it was purchased 3 years ago

4 credit cards all paid on time(all over 2 years old). 

Card 1 Balance= 250.00      Credit Limit= 5000.00

Card 2 Balance= 199.00      Credit Limit= 2500.00

Card 3 Balance= 125.00      Credit Limit= 4,000.00

Card 4 Balance= 900.00      Credit Limit= 10,000.00

                                                                     VS

Client B: Has a 140K mortgage that has bee paid on time since the home was purchased 3.5 years ago.

An Automobile payment of 301.00 per month, paid on time since it was purchased over 2 years ago.

5 credit cards all paid on time(all over 2 years old).

Card 1 Balance= 2485.00      Credit Limit= 2500.00

Card 2 Balance= 910.00        Credit Limit= 1000.00

Card 3 Balance= 4,600.00      Credit Limit= 5000.00

Card 4 Balance= 1325.00       Credit Limit= 1500.00

Card 5 Balance= 792.00         Credit Limit= 750.00

 

As shown the primary difference between Clent A & B is the ratio of used credit(Balance) to available credit(Credit Limit).

While client A has kept their balance low(under20%), client B maintains a high balance of over 90%. On card 5 they are over 100%!

The result in this example is that client A has a 760 credit score and client B has 629 credit score. This is due to the fact that when a revolving debt account has a decreasing available balance, the credit reporting system sees it has a sign of financial stress, therefore a higher credit risk is assigned to that report, resulting in the lower score for client B

It is also important to mention that should a collection or a late payment appear on either one of these clients reports, it is client B that would be most adversly affected(easily could push their score to below 620) due to their high debt ratio on their credit cards.

The cure for client B is to start paying down their credit cards with the smallest balances first, and to keep their balances under 40% of their available credit limit on average.

Today it has become even more important to maintain a higher  credit score as both FHA & Conventional mortgages have moved to the "Risked Based Pricing Model" which rewards with lower interest rates for higher credit scores, saving you money.

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Tags:
credit score
revolving debt
risked based pricing
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Ambassador
1,927,408
Steve Hoffacker
New Home Sales Trainer/Coach, Sales Books Author
Hoffacker Associates LLC

Bryan, I can understand the questions and they make sense. As long as a person is never late on their mortage - to the point of even putting off other creditors - and you are only lending them money on their home, why would you care?

June 08, 2008 12:25 PM
Rainer
102,732
Robert Huntsinger
Empire Realty Upland, CA - Full Service at a Discount
Empire Realty

This is good information it puts it in context for the layman.

Take care!

RJH

June 08, 2008 12:28 PM
Rainer
320,761
Chip Jefferson
Gibbs Realty and Auction Company

Knowing how to maintain the proper ratios will keep the score looking good. This is the hardest thing to teach to people that don't know.

June 08, 2008 12:29 PM
Rainmaker
182,471
Kara Casamassina
Boomers and beyond
Carolina Real Estate Company

thanks for the explaination.

June 08, 2008 12:36 PM
Ambassador
1,637,838
Fernando Herboso - Broker for Maxus Realty Group
301-246-0001 Serving Maryland, DC and Northern VA
Maxus Realty Group - Broker 301-246-0001

grat info

June 08, 2008 12:40 PM
Rainmaker
570,044
Bill Gillhespy
Fort Myers Beach Realtor, Fort Myers Beach Agent - Homes & Condos
16 Sunview Blvd

Hi Bryan,  Excellent review of the credit scoring system.  More people need to know how the scores are computed.

June 08, 2008 01:03 PM
Rainer
9,211
Bryan King
Ascent Home Loans

Hi Steve,

I care because it is important that people are informed about this basic information that has a major impact on not only what they pay for a mortgage, but other things, such home & auto insurance, etc . All of these are affected by credit score, and simple changes on how they manage their revolving debt, etc., has a major impact on their credit life. 

June 08, 2008 01:20 PM
Anonymous #8
Anonymous
Anonymous

Bryan, great post and easy to read explanation. Thanks for giving us some incite.

June 08, 2008 01:23 PM
Rainer
331,895
Danny Thornton
WordPress Guru
R & D Art

Bryan, this is well put together. People need to know that their entire credit is under review when they are borrowing for a home. The impact is simple. If you can not manage your credit then why would any responsible lender take a risk? If you can, then you deserve the very best.

June 08, 2008 11:39 PM
Anonymous
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Rainer
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Bryan King

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