In today’s lending environment, credit scores are more crucial than ever

WASHINGTON -- With the resurgence of tighter underwriting standards, some mortgage-market observers have been predicting that lenders would once again rely more on a would-be borrower's overall worthiness and less on his or her credit score. But if anything, credit scores have become more critical, not less.

Lenders are now giving more credence to each of the "Five C's" -- character, capacity, collateral, capital and credit. But your credit score, which is a numerical snapshot of your credit history at a single point in time, is still paramount, says David Chung, managing director of CreditXpert, a Towson, Md., firm that sells credit-management tools to lenders.

Just a few months ago, a credit score of 620 was good enough to obtain the best mortgage rates and terms available. But the bar has been raised considerably. Many lenders now require a minimum score of 680 to qualify for a prime loan. And some won't even make a loan to anyone whose score is below the new benchmark.

"Everyone's gotten extremely conservative," Chung says. "The gold-rush era is over; 680 is the new 620."

On top of that, in cases in which borrowers don't make at least a 20 percent down payment, investors who buy loans from local lenders and insurers that protect the loans' owners against borrower default are charging extra fees. And the bar has been raised even further in the big-money "jumbo" loan sector. In the realm of $417,000 and beyond, you need a higher score and even more money down to obtain the best rates and to avoid the add-on fees.

Since the significance of a good credit score cannot be overstated, it is important for borrowers to understand how to raise their own bar. And you start that process by making sure that the information contained in the files maintained by the three credit bureaus is accurate and up-to-date.

You need to check your histories with all three repositories -- Experian, TransUnion and Equifax -- because each receives information from different creditors. Your local department store may report to one bureau, for example, but not the other two. In addition, information often is reported at a different time, say, at the end of the month or only once every three months.

If you are one of the estimated 50 million Americans who have little or no credit records on file with the three bureaus, you can still have a credit score if you, among other things, pay for rent, cable television, phone service, utilities, furniture rentals and health-club memberships.

These are regularly recurring bills that are not typically included in data used to compile a credit score. But recent high-school and college graduates, immigrants and "unbanked" people who pay with cash or money orders can use them to create what is known as a "nontraditional" credit history.

Credit Plus, a Salisbury, Md., credit information service, now allows consumers to post their payments online with PRBC, a consumer reporting agency that collects, stores, scores and reports nontraditional payment data.

"Nontraditional credit reports have been gaining greater acceptance in the mortgage sector," says Allen Johnson, the firm's vice president of sales and marketing. "So this is a powerful tool for those who have been neglected by the regular credit system."

Obviously, paying bills on time shows you are a person who takes credit responsibilities seriously. On the flip side, late payments are always bad.

Credit scoring is based on complex formulas containing as many as 300 characteristics that might be predictive of the likelihood that someone will meet credit obligations. Of these variables, though, about two dozen are considered the most predictive, so you can raise your score by understanding some basic rules.

Actually, the term "rules" is inappropriate here. There are so many permutations, and the scoring systems are so complex, that it is "dangerous to depend upon instinct or generalizations" to support steps you take to improve your score, says CreditXpert's Chung. Nevertheless, there are some basic credit truths.

For example, the longer a consumer's credit history, the better. Files that go back 30 years are ideal. But a three-year record will do the trick. Johnson of Credit Plus says a record of 12 or more consecutive on-time monthly payments will help borrowers obtain financing.

Managing debt load is also recognized by the scoring formulas. Consequently, keeping your credit below half of your limit will improve your score. But keeping it below 30 percent -- $300 on accounts with a ceiling of $1,000, for example -- is ideal.

Delinquencies, of course, are negatives. But when a late payment occurred is also important. Recent late payments will reduce your score significantly, while a late payment or two that took place years ago will cause hardly a ripple. Even judgments against you that are more than two years old won't damage your score as much as a 30-day late payment last month.

Paying off credit cards in full each month will not necessarily raise your score, either. If the balance is high on the day the credit-card company reports to the bureau, that's the amount the score sees.

Scoring models also look for well-balanced credit -- not just balances but also the number of credit cards in use. There is no optimal number, but typically people with too many or too few are considered higher risks.

Because much of what goes into a credit score is counterintuitive, the best way to improve your score is to work with a lender or broker who uses credit-optimization software that identifies key influences.

For example, credit accuracy detection programs scrape information in each of the three credit bureaus' reports for inconsistencies, errors and omissions that could be artificially depressing your score.

Lew Sichelman has been covering real estate for more than 30 years. He is a regular contributor to numerous shelter magazines and housing and housing finance industry publications.