How Much Does Your FICO Score Really Matter?

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How Much Does Your FICO Score Really Matter?

In 1956 when an engineer named Bill Fair (*or Grandpa Bill as I used to call him) and a mathematician named Earl Isaac formed Fair, Isaac and Company (or FICO), they created a credit scoring system that has grown to become the most widely used credit scoring system in finance today.  Your FICO score may be as important as any other number in your life, as it can have a life changing impact for better or for worse.  In this post, I’ll tell you some of the positives and negatives that can affect your FICO score, as well as share examples of the financial impact of your FICO score.  I’ll also offer some credit tips and advice I’ve learned from my own experience as well as the experiences of my clients over the years.

First of all, it is important to understand some of the many reasons that your FICO score matters.  For my purposes, mortgage lending, your FICO score will determine two key factors – eligibility for a loan program and interest rate that you will pay for the life of the loan.  This means that your FICO score will literally either open or close the door to your new home.  Either you’ll get the keys or you won’t.  It also means that the amount or your monthly payment, potentially for the next 30 years, will be higher or lower depending on your FICO score.  Other uses of your FICO score include employment screening, insurance underwriting, and even **dating websites.  Your FICO score can be an influence in whether or not you land your dream job, pay higher or lower rates for insurance products, and even **possibly prevent you from finding your Mr. or Mrs. Right!

Some of the factors that can influence your FICO score for the negative are derogatory items such as: late payments, collections, charge-offs, repossession, foreclosures, and bankruptcies.  In addition, some non-derogatory factors can also negatively impact your credit, in the short term, such as: excessive inquiries in a short period of time, new trade lines (credit accounts), and high revolving credit utilization.  While derogatory items will have a long-lasting impact on your FICO score, the non-derogatory items can quickly be turned from negatives into positives.  I’ll offer some tips for improvement, but first I’ll give some examples that quantify the correlation between your FICO score and the dollars in your bank account.

For example purposes, we’ll use a scenario of a buyer purchasing a single family residence for $400,000, putting 20% ($80,000) down.  The loan amount would be $320,000, and we’ll use a 30 year fixed rate, based on recent actual pricing (This is not today’s quote, and is for example purposes only.  Please contact me for current rates on your particular scenario).  With all costs being equal, no points, and the only difference being FICO score, these would be the rates and payments:

619 FICO or lower – ineligible for conforming financing.

620 to 679 FICO – 5.125%. Principal and Interest payment of $1742

680 to 699 FICO – 4.875%.  Principal and Interest payment of $1693

700 to 719 FICO – 4.750%.  Principal and Interest payment of $1669

720 FICO or higher – 4.625%.  Principal and Interest payment of $1645

There are many different comparisons that can be made, and different ways to examine these numbers.  For example, if your FICO score is less than 620, you wouldn’t be able to qualify for a conventional loan to buy this home (there are other types of loans available).  With a FICO under 680, versus a FICO above 720, the payment comparison is $1742 versus $1645, a difference of $97 per month.  Over the 360 payments of a 30 year loan, that would $34,920.  We’re talking about the cost of dinner and a night out once a month, or the cost of a nice new car over the life of the loan.  Either way you look at it, I’m sure you would rather have the dinner money or the new car savings than not.

To keep your FICO score working in your favor, here are some tips and advice:

First off, avoid any of the derogatory categories – late payments, collections, charge-offs, repossession, foreclosures, and bankruptcies.  The best way to do this is to budget wisely, live within your means, and always make your payments before the due date.

To protect against excessive inquiries, avoid running your credit more often than you need to.  An online, self-generated report or a credit monitoring service does not count as an inquiry.  An inquiry is when you apply for a credit account, with a bank, department store, or other vendor that offers credit products.  If you have had a lot of inquiries within a 12 month period, the only solution is time.  The longer your planning stage is for buying your home, the more time you have for old inquiries to disappear.

If you have recently opened any new accounts, new trade lines opened less than six months can bring down your FICO score.  The only solution for this one, as well, is time.  After six month, a positive payment history will actually improve your FICO score.  The best advice I can offer is not to open any new credit accounts, if you’re planning to buy within six months.

Finally, avoid high revolving credit utilization.  What this means, is try to keep your revolving accounts (credit cards and credit lines) below 30% of the limits.  The closer your accounts are to their limits, the more impact this category will have on lowering you FICO score.  Keep in mind that when a credit report is run, it is a snapshot of your current credit picture.  Even if you pay off a credit card entirely, each month, whatever the balance is when the creditor reports to the bureaus is the balance that will be on your credit report.  If the balance is over 30% of the limit, this will impact your FICO score negatively.  For this reason, I usually advise my clients to avoid using credit cards, and use only their debit cards, during the house-hunting and escrow period.  This means you’ll need to avoid furnishing your new house until your loan is closed and you have keys in your hand, if you’ll be using your credit to do so.

As you have seen, your FICO score is a very important factor in many areas of life, from employment, to insurance, to borrowing, or even dating **.  Having good credit can save you tens of thousands of dollars or more, in your lifetime.  Following the advice detailed above will ensure that your FICO score doesn’t hold you back from reaching your dreams. My *Grandpa Bill always said, “Work hard, budget well, and use your credit wisely, and you’ll do alright.” 

I hope you enjoyed this post.  Please contact me or send me a message on Facebook  with any feedback, questions, or future blog post ideas.  Be sure to “like” my page and subscribe for future posts.

*Although we share the same last name, Bill Fair was not my grandfather, my Grandfather’s name wasn’t Bill, and I am unaware of any actual relation.  There are many branches of the family tree that I am not familiar with, so we might be related!  I made up the quote, but it sounds like good, grandfatherly advice, so try to follow it.

**I haven’t actually verified that any dating websites run credit, but if they don’t, maybe they should.  When applying for joint credit, the lower borrower’s FICO score is the one that counts, so your significant other’s FICO score is as important as your own.

What is your American Dream?

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In a recent purchase transaction, my buyer gave me the compliment that we helped him to achieve his “American dream.”  I’ve had many great testimonials from clients and referral partners, but this one really stands out to me.  When I think about what I do for a living, what makes me the most proud of my work is that I help people achieve their dreams of home ownership.  My client called this his “American dream.”  What defines one person’s American dream can be vastly different from another person, but building wealth is certain to be a piece of the puzzle for most people.  Achieving home ownership is a great start toward building wealth.

As discussed in my post on owning versus renting, more wealth has been built by real estate ownership than in any other way over the past century.  And your first home will often lead to a superior second home or many homes.  Whether you build wealth by owning your own home, or by owning many homes, real estate is a great way to build wealth.

I always enjoy working with buyers who believe in themselves and that they will build wealth through real estate.  Even when buying their first home, they’ll tell me that this is just the beginning, and talk to me about their long-term plans of owning many homes.  I especially enjoy it when they come back to me to buy their second home or even their third or more.  They understand the underlying principle that if you can build wealth by paying down principal, you can build more wealth by letting someone else pay down your principal – a tenant.  It’s not a “get rich quick” scheme.  It’s a slow and steady progression of paying down more and more principal each month , building wealth one payment at a time, through home equity. 

But you’ve got to have money to make money, right?

Wrong.  You can buy your first home with as little as $0 of your own money.  This sounds too good to be true, right?  The Federal Housing Authority (FHA) allows for a down payment of as little as 3.5% of the purchase price.  This can even be accomplished on a 3 or 4-unit property, as long as it passes the FHA Self Sufficiency Test .  FHA also allows for gift funds to be used for all closing costs and down payment.  A quick conversation with Mom and Dad, and you’ll be all set with your gift funds, and ready to buy a home with $0 of your own money.  Ok, it might not work out as easy as that, but with some of your own savings, and some help from your parents if needed, if they’re willing, you can be an owner/landlord in no time.

Once you own a property, where the full payment (PITI) is covered by the rental income from your tenants, you’re on your way to building wealth in real estate.  Many people think that the wealth made in real estate comes from the rental cash flow.  The cash flow is some nice extra spending money, but it’s only part of the picture, and not the most important part.  The monthly principal reduction is true benefit.  Assuming your property holds its market value over the years, each month your principal reduction is like a forced savings account that you will have access to “someday,” but can’t touch or spend now.  For some who lack the discipline to save money, this a great benefit.  This is the piggy bank that doesn’t have a removable plug in the bottom that will really force you to save over the long-term.

So how do you access the funds in that piggy bank? 

Based on the amortization schedule month, assuming your starting loan amount was $300,000 at 5%, over 30 years, after five years, you’d have paid down about $25,000.  After 10 years – $56,000, and 15 years – $96,000.  If you wanted to access those funds to buy another home, or invest, or for any other reason, you’d have a few different options.  You could sell the home, refinance it for cash out, or take out a second mortgage or home equity line of credit.  It’s much more secure than the piggy bank with the plug at the bottom, or even the one without that you’d need a hammer to access.  Whichever route you choose, it is a process that will take some time and some planning, so it’s best to plan ahead. 

Whatever your American Dream is, owning your home, or owning many homes can be a great way to build wealth and to reach that dream.  With patience, and a long-term outlook, and possibly letting tenants pay down your principal balance for you, you can achieve whatever level of success you desire.  If you have questions about loan programs or want to look at any specific scenarios, I’m here to help!

 

Fantastic Testimonials by Satisfied Clients

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#Happy‬ ‪#‎Wednesday‬, I just thought I’d share this ‪#‎short‬, but ‪#‎sweet‬ ‪#‎Testimonial‬ by another one of my ‪#‎Satisfied‬ ‪#‎Clients‬: http://goo.gl/U3PgvF

Rent vs. Own – Back to Basics

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Rent vs. Own – Back to Basics

Over the past few years, we have been spoiled by ultra-low interest rates.  The renting versus owning debate has really been a “no-brainer.”  Due to rates in the mid-to-low threes, there really was no argument.  In most cases, with a decent down payment, it really was cheaper to own versus renting.  Many of us in the industry simply pointed out that a housing payment (PITI – Principal, Interest, Taxes, and Insurance) of $1750 is cheaper than the $1800 you’re paying in rent, so it makes more sense to buy.  The numbers were there, so the conversation simply ended as there was nothing to debate.  The contract was signed.  The offer was made.  As we were spoiled by the low rates, we got lazy with this conversation, and some may have forgotten the true benefits of owning versus renting.  Well, now that rates are so high (the mid-fours are considered high now!), it’s time to get back to basics.  This article will be a refresher to most, of the benefits of owning versus renting.  But if you’ve only been in real estate for the last few years, this may be new information for you, which you can share with your clients.

When rates were in the threes, a buyer with good credit could put 5% down and get a loan on a $300,000 purchase, with a full PITI payment of $1697 at 3.750%, with no mortgage insurance (Ask me about the 5% down, no MI conventional loan).  With a housing payment of $1697, there really wasn’t much more that was needed to convince a renter paying $1800 per month that it makes more sense to buy.  With the rise in interest rates, this same scenario today would be a loan at 4.875%, with PITI of $1886.  To your renter paying $1800, this seems to be higher than their monthly rent.  Now is when we get back to basics and look at the real numbers to see that it is still cheaper to buy than to rent.

First of all, before we have this conversation, I need to make it clear that I am not a tax advisor and I do not give tax advice.  For tax related questions, please consult a licensed tax professional.  You’ll want to make this clear if having this conversation with your client, unless you are actually a licensed tax professional.  And if you are a licensed tax professional, please let me know if you see any errors and I’ll be happy to correct and give you credit.

Mortgage interest and property taxes may be tax deductible (see previous paragraph).  From our previous loan scenario, of the $1886 PITI payment, the principal and interest portion of the payment is $1508.24.  For the first payment, this breakdown is $1157.81 interest and $350.43 principal.  Assuming 1.25%, the tax portion is $312.50.  If you are able to deduct the taxes and interest, that is a monthly deduction of $1470.31.  Assuming you are in the 25% Federal and 10% State tax brackets, being able to deduct this amount from your income means that you are overpaying your taxes by 35% of this amount.  In other words, when considering the (potential) tax deductibility, your after-tax portion of the interest and taxes would be $955.70.  This would make your total after-tax payment $1371.  Therefore, if your monthly rent amount is greater than $1371 (for this example) you would be saving money with a total mortgage payment of $1886.  Please contact me if you need any clarifications on these calculations.

Ok, now that the math lesson is over, let’s consider another part of the PITI.  P is for principal.  Each month slightly more of your payment goes to principal and less to interest, as you pay down your balance.  As noted above, the first month’s principal reduction is $350.43.  Each of the next 359 payments would be more than the last, until you have paid off the full $285,000 original balance.  If net worth is measured by assets minus liabilities, principal reduction can be looked at as increasing your net worth each month.  In fact, more wealth has been built by real estate ownership than in any other way over the past century.  After five years of payments in this scenario, the principal would be reduced by almost $24,000, and almost $54,000 by the end of 10 years.  The principal reduction drastically accelerates in the later years of the loan.  As a renter, you are also building wealth through principal reduction – for your landlord!

The equity in your home can be used to fulfill countless life needs.  Just to name a few, you can pay for college, fund your retirement, or use it to invest in more property or other investments.  Your first home will often lead to a superior second home or many homes.

One other benefit of owning versus renting is the ability to be creative and design your home any way you see fit.  You can paint your walls your favorite color.  You can build a fence or a deck.  You can even paint your fence or your deck.  Whatever you decide, it’s up to you.  As a renter, many times you need your landlord’s permission just to hang a painting.

These are just a few of the basic benefits of owning versus renting a home.  With interest rates heading back to “normal” levels, it’s important to understand the true benefits of home ownership, rather than just “a lower payment.”  Happy house hunting.

*Payment quotes are for example purposes only.  These rates may not be current, and this is not a commitment to lend.  Every lending scenario is unique, so please contact me for your specific scenario.