As a direct mortgage lender dedicated to helping my real estate investment clients build wealth, I have a unique vantage of the counter-intuitive nature of credit scoring and reporting. Often, individuals with higher net worth don’t leverage their assets in a way that optimizes their credit scores.
For example, you’d think a client sitting on $400,000 in home equity, about to sell his house in this hot market and move to a condo in preparation for retirement, would be a underwriting dream. You’d think, if you were a logical person, that his careful management of his money would net him very best interest rates available.
Yet time and again, my team sees clients who have done “all the right things” but don’t get the benefits of the highest credit scores, which means they would leave money on the table by paying a higher interest rates.
Proactive intervention can save these people tens of thousands of dollars in interest over the life of a loan. So it’s important to talk to your mortgage lender the moment the notion to buy, sell or refinance occurs to you. With the right team in your corner, you can leverage your “right moves” to reflect in your score.
Reasons for Lower Scores in HNWIs
Let’s take my guy “Sam” for example. He’s a big Dave Ramsey fan, so he’s dutifully paid off his high-interest, revolving credit cards and closed most of the accounts. Plus he saved up to buy a used Ford F-150, cash. The one credit card he keeps open, he makes sure to pay off in full every month, no matter how high the balance.
In other words, he’s admirably managing himself and his assets by most accounts….unless you’re a lender looking at the weighted FICO score that adds up differently in the alternate universe of credit scores.
The Alternate Universe of Credit Scores
The difference in interest between someone with a “good” score of 700 and an “excellent” score above 760 can be hundreds of dollars a month in interest and thousands per year. There are actually different types of credit scores used for different scenarios, such as revolving credit, auto, and home loans.
For home loans, this is the weighted mix of the FICO score:
- Payment History (35% of score)
- Amounts Owed (30% of score)
- Length of credit history (15% of score)
- New Credit & Inquiries (10% of score)
- Types of Credit (Mix) (10% of score)
By this standard, Sam doesn’t look as good as he is, at least on paper:
- Sam lost positive history and score weight by closing credit cards, which would have contributed to a low utilization percentage. For example, if you have a total of $20,000 credit available and used only $5,000, you’re at the desirable 25% utilization. Now that Sam is down to a single card with a $10,000 balance, a month where there’s $5,000 in charges, even if paid in full at the end of the month, might report as a 50% utilization – which negatively affects his utilization score, worth 35% of his overall report weight.
- By paying off the credit cards and not having a car loan or mortgage, Sam will not have the desirable mix of credit lines lenders prefer to see. He has also depleted his cash reserves by buying the truck. Mortgage lenders in some cases like to see 6 months worth of income in savings.
- Sam may also have left himself unable to buy a new condo until he sells his house unless he has other liquidity available. He will not be able to bid competitively on a condo without a solid pre-qualification letter, and if much of his income isn’t earned income, that can pose another set of challenges.
Sam’s Solutions & Considerations:
- Sam could reopen some of his revolving credit accounts and have small monthly payments be charged to them. He could distribute his credit card charges across different accounts, ensuring he does not exceed 30% utilization.
- Sam would be well-served to investigate a HELOC before listing his house for sale. He would then have the cash available to purchase a condo when he finds the right one.
- Sam would likely have substantially more money in his retirement fund in 15 years if he used a large share of his proceeds to aggressively contribute the maximum each year for the next several years, and mortgaged a higher amount (but not more than 80% to avoid mortgage insurance).
Cash may be king, but credit score is Queen when it comes to great rates. Proactive review of your credit score by a mortgage specialist is a great way to prepare to make a move, whether you’re trading up or right-sizing for retirement.
Everyone, not just young folks starting out, can benefit from these general credit tips, plus a well-vetted review when it’s time to make a move.
- Consistency long-term is key to a great credit score
- Everyone should check their credit annually: annualcreditreport.com (FREE)
- You must use credit to have credit
- Keep old accounts open
- Don’t request lower limits on open accounts
- Keep credit pulls to a minimum
Don’t let “good habits” prevent you from qualifying for the best rates. Know the score on your Credit.
Please feel free to access our Free Guides on this and other topics to help investors at our website: http://www.michiganhomeloansolutions.com/guides