For years, lenders have utilized "credit scoring" to determine whether or not an individual is a good credit risk. Credit scoring has recently become a hot topic, due in large part by the mortgage lending industry's willingness to use the process to evaluate one's likelihood of repaying home mortgage refinancing or second mortgage loans. Even insurance companies use credit scoring as part of their underwriting procedure when writing automobile and home insurance coverage.
Credit scoring is a system, based on a statistical program, which awards points for certain factors that help predict who is most likely to repay a debt, such as a mortgage refinancing or second mortgage loan. The total number of points, or score, is what lenders use to determine an individual's creditworthiness. A large random sample of customers is taken, and analyzed statistically to identify characteristics relating to credit risk. These factors are then given a weight based upon how strong a predictor they are of who would be a good credit risk.
Credit scoring models do vary from lender to lender, but most generally include the following factors:
1) Your current amount of debt as compared to your potential total available credit.
2) Payment history on current and previous accounts.
3) The length of your credit history.
4) The number of credit inquiries (each time a creditor pulls credit in response to your application).
5) The number of separate open accounts.
6) Collection actions including judgments, repossessions, foreclosures, and bankruptcies
Using the statistical program, lenders compare this information about you to the credit performance of other consumers with similar profiles. Therefore, it is usually more reliable than a subjective or judgmental decision, because it is based on real data and statistics. Although it may seem somewhat impersonal, when used properly, credit scoring can allow creditors to evaluate credit applications faster and more accurately than individuals, in an impartial and unbiased manner.
In addition, the home mortgage refinancing and second mortgage loan process has been shortened as a result of the speed in which mortgage lenders can now make decisions utilizing the credit score model.
Bob Peckenpaugh is a professional mortgage planner with over 15 years lending and banking experience. His programs assist clients with increasing cash flow, reducing liabilities and building equity by integrating a client’s mortgage decision with their overall financial plan. He is a manager with CFIC Home Mortgage providing both purchase and refinance transactions. Bob holds a B.S. in Marketing and Management and is Fair Credit Reporting Act certified.
For additional questions or comments about this article, please contact Bob Peckenpaugh at amfcorp@comcast.net or 1-800-943-9472.
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