CREDIT MAKEOVER IN FIVE STEPS

A lot of homeowners have the mind set that making payments on time automatically equates to good credit and credit scores.

Unfortunately, this couldn’t be further from the truth.
While paying your bills on time accounts for a large portion of your credit score, there’s still a lot more to it. In fact, paying your bills on time only drives 1/3rd of the points in your credit score, which means that 2/3rds of your score has nothing to do with making on time payments.
Five main categories go into making up your overall credit score calculation. Let’s briefly review each category and how much they count:

1. Payment History – The Most Important Category

This category is pretty self-explanatory. It doesn’t take a rocket scientist to figure out that if you pay your bills on time, you’ll do well in this category. Likewise, if you have a history of late payments, collections, chargeoffs, public records, etc. – you’re not going to do so well in this category.

In addition, the number of negative items on your credit reports is important. The more incidents of credit transgressions, the more your score will suffer. And if you have recent negative information that will punish your scores more than if they are several years old.

2. Debt – A Very Close Second

The most important non-payment category in your credit score is, by far, the amount of debt that you carry. And while your installment debt (auto loans and mortgages) are factored into your scores, it’s really your credit card debt that’s most important.

This includes anything from Visa, MasterCard, Discover, American Express, gas cards and/or retail credit cards like Macy’s or Target. The balances that you carry on your credit cards can affect your scores almost as much as whether or not you make your payments on time.

This category calculates the proportion of balances to credit limits on your revolving credit card accounts – also referred to as ˜revolving utilization’. Simply put, the higher your revolving utilization percentage, the fewer points you will earn in this category.

So what is revolving utilization and how is it calculated?

To determine your revolving utilization, you’ll need to add up all of your current balances and all of your current credit limits on your open revolving credit accounts (except for Home Equity Lines of Credit). This will give you a total balance and a total credit limit. Divide the total balances by the total credit limit and then multiply that number by 100. This will give you your total revolving utilization percentage.

See the example provided below:

Remember, the lower your utilization percentage, the more points you’ll earn and the higher your credit score will be. To earn the most possible points in this category, you should try to keep your revolving utilization at 10% or less. If you can’t reach 10%, just remember that the lower the better. While 50% is better than 60%, 40% is better than 50% and so on.

How you pay your bills and your revolving utilization are by far the most important factors used to determine your credit scores. They account for 2/3rd of the points in your score. That’s a hefty chunk! Needless to say, if you don’t do well in both of these categories, your scores aren’t going to be very good regardless of how you do in the remaining categories.

While the remaining categories are worth fewer points, they are still very important for consumers who want to earn the highest scores possible, certainly a requirement in today’s difficult credit environment:

3. The Age of Your Credit History - Secondary Category

Don’t confuse this with your age. It’s the age of your credit reports. Basically, the score is looking to see if you have a lengthy history of managing your credit obligations. The age of your credit history is determined
by the “date opened” on the oldest account listed on your credit report. The older your credit report, the more points you will earn in this category.

There’s really not much you can do in this category except wait it out. As your reports get older, you will gradually earn more points. This means that you should never try and get old, good accounts removed from your credit reports.

You want the history!

4. New Credit/Inquiries – Secondary Category

When you apply for credit you are giving the lender permission to pull your credit reports and credit scores. Each time this happens, your credit report will reflect what’s called an “inquiry.” To perform well in this
category, you should really only apply for credit when you need it.

5. Credit Mix – Secondary Category

What types of accounts do you have? You will do well in this category if you have a nice diverse list of different types of accounts in your credit report. This includes mortgages, auto loans, installment loans, credit cards, etc.

If your credit report is dominated by one type of account (or lack of others), this could negatively affect the number of points that you earn from this category.

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That pretty much covers the factors that are used in determining your credit scores. Let’s do a quick recap:

1. How you pay your bills – on time is good, late is bad

2. How much you owe your creditors – keep your credit card debt low (10% utilization is optimal)

3. How long you’ve had credit – the longer the better

4. How often you apply for credit – apply only when you really need it

5. Account mix – diversity is good
If you can stick by these five key principles, you should be well on your way to healthy credit and credit scores.

• Measure is unnecessarily complex and riddled with procedural traps
• Promotes strategic defaults negatively impacting communities
• Fails to require tender by borrowers as a symbol of good faith
• SB 1275 invites litigation through inclusion of TWO private rights of action
• Inappropriately meddles with pending litigation
• The measure may be preempted for federally chartered institutions creating an unlevel playing field exacerbated by the recent credit union only carve-out

 For full bill text, click here

To read more about the California Mortgage Brokers Association’s opposition, click here

Here’s a handy summary of the two tax credit laws (what just expired and what the new tax credit for California buyers has to offer):

Information compiled by the California Association of Realtors®. Comstock Mortgage does not give tax advice. Please consult a qualified tax professional for all tax related matters including eligibility for home purchase tax credits.

Forget for a moment the vast legal and moral reasons to keep your home and make the payments you agreed to when you bought (or refinanced) it in the first place, even though those reasons have become easier to dismiss in today’s world, and realize there are some very real consequences to defaulting on your mortgage, not limited to killing your credit score and making it so you can not buy a home (and lose all of the REAL benefits of being a homeowner) for at least 2 to 3 years. In the short-term it seems obvious, why keep making payments on something that isn’t even worth the debt that is carries? One big piece of the American financial system is how much leverage is built into the housing market and being a homeowner. People who wouldn’t consider borrowing money to invest in anything else gladly pile on the leverage when it comes to Real Estate, often borrowing close to the full purchase price of the home (a great financial strategy if used correctly). Of course that is because most of us don’t have the cash to buy a home outright – and if we did it would be the worst financial decision we could make, but that is another story for another day - but however our homes are an asset like any other. Like all assets, values go up and down and leverage magnifies both losses and gains.

Lets look at a home that sold in Roseville during the height of the market in 2005 or 2006, it sold for $450,000 and the family put 10% down when escrow closed obtaining a conforming mortgage of about $405,000. Lets assume all homes in Roseville have dropped about 25% in value since, and the home is worth now $337,500. If this homeowner stops making payments and “walks away” from the home they automatically lose their $45,000 down payment, all interest paid, and principal payments as well. A huge financial loss. People looking at this option sometimes still seem to think walking away from their home and the mortgage is the right move, capping the losses there. The Sacramento real estate market is not good for sellers and probably wont be for a while and they can probably rent the nicer house next door for less than their current mortgage payment. In a simple world this makes sense, but our world is not that simple.

This decision assumes a static housing market where home prices are fixed at their current low values (real estate always appreciates when viewed over the longer-term period and we’re already seeing prices stabilize and start to rise since last Summer). Everyone knows the ABC’s of investing, buy low sell high, but just like the stock market people do it backwards. Selling on the bad news and buying when prices have come back up, in this case it’s no different with Real Estate. People are essentially “selling” low, the exact opposite of what they should. Assuming prices continue to stabilize and appreciate at a modest annual rate of 5% (the National Association of Realtors data shows average appreciation of 6% historically, even taking into account the huge drop in home prices of the last 2-3 years) until the loan is paid off in 2035, this Roseville home will be worth approximately $1,200,000. Of course this homeowner might not want to wait 25 more years, they may want to sell 10 years from now, when this home will be worth $549,750, a decent gain of more than $200,000 more than today’s value, and still $100,000 more than the original purchase price. Which we’ll remember was purchased at the height of the market back in 2005. In my opinion that doesn’t seem too long to realize a $200,000 gain compared to almost a $100,000 loss by walking away today. Especially considering this investment is your home, the place you live, where you keep your stuff, raise you kids, etc. There’s a real good chance you’d been keeping it for 10 years anyways.

Then there is the opportunity cost of walking away with home prices at the bottom of the market and likely to go up. By the time those walking away today are again credit-worthy enough to obtain financing for a new home they’ll have missed years of appreciation, low interest rates, and today’s rental rates will have gone up. Possibly stuck as a renter forever because they can’t afford the current home prices at current rates five years from now. Before long their rent will assuredly be more than they original mortgage payment was and there will be nothing they can do about it.

In the end I hope you see the case for staying in many situations, and that that case is far more compelling that first it seems. Not to mention fulfilling one’s obligations is just the right thing to do. So there is more than just financial reasons for doing so (and we didn’t even take into consideration all of the lost tax benefits of not owning a home, higher interest rates paid on all other credit and other accounts, such as utilities, chance of not getting a job, a deficiency judgment levied by the current lender, massive IRS fees, etc that we won’t have to face/lose if we make the decision not to “walk away”). If anything I recommend homeowners look into one of the government’s new refinance programs to take advantage of tofaday’s low rates, or talk to their lenders to try and get a loan modification or modified payment plan. In reality it’s the monthly payment that matters most right now, and that payment was just fine when your home was worth more, if you can get a lower payment it’s just the obvious and right thing to do.

~ Greg

While I believe a short sale is a much better situation for our local economy as a whole it is not a guarantee that the seller can run out and buy another home today. In fact it’s quite the opposite: IF you were not forced from your existing home due to a job transfer or dramatic illness and therefore proceeded with a short sale, you are probably not going to get a new home loan for a MINIMUM of 24 months and more realistically 36 months.

Why am I harping on this issue so much? There is a lot of bad information being thrown around in the local real estate and mortgage world, especially in marketing (suprise suprise). Those of us that are “teachers” in the Sacramento real estate and mortgage land need to regain the trust of the home buying/borrowing community. Over the last few years, many in the general public feel they have been taken advantage of by lenders, realtors and just about everyone else. Now is a time to give good, honest advice to people: Even if it is not exactly what they want to hear and it does not meet their immediate goals.

I’m confident that as time rolls on, we will see a softening of these rules. Please feel free to call me with any questions.

Of course Fannie does not control everything and this will only apply to foreclosed homes that are currently in the agency’s possession but that is a big chunk of the foreclosure market and this program may make a difference. As many of you may know it’s been difficult for many people trying to buy their first home to have as they continue to lose bidding wars with cash investors. The program will also help buyers in this part of the market by accepting offers with as little as $500 in earnest money deposits, and making the process of renegotiating after a low appraisal easier.

The other GSE, Freddie Mac, says they have plans for a similar program but have not announced any detials so far.