How To Determine Your Credit Grade
Looking for a guide to your credit grade? Our guide to your credit grade helps borrowers understand how their credit score is arrived at so they can be better prepared when they meet with mortgage lenders. You need to understand, however, that this information is provided under a general premise. Not all lenders will stay true to what is written below. With that said, the following section will help you understand the main factors that determine your credit grade.
Understanding Your Credit Grade | The Main Contributors
Your credit is determined by three major factors. First, your mortgage credit is in essence the history of payments on your either existing or previous home loan. This repayment history acts as an indicator for lenders, proving how loyal a borrower is to their mortgage obligations.
Second, is a borrower’s consumer credit, which relates to both installment and revolving credit. Installment credit refers to the long-term payment plans, such as car loans and student tuition loans, whereas revolving credit covers payments made on credit cards. A payment is considered late if it is received thirty days after the due date.
The third factor encompasses public records, such as bankruptcy or foreclosure. As for the grade, an A-grade borrower cannot have any record of a bankruptcy within the last two to ten years, whereas a D-grade borrower is likely to currently be in bankruptcy. As credit problems worsen, the borrower’s grade goes down, leading to an increase in rates and fees assessed by the lender.
The Debt Ratio
Along with credit assessment, lenders also evaluate the borrower’s ability to repay the loan on time. In order to do so, lenders divide total monthly debts (housing expenses plus other credit obligations) by total monthly income to get the debt ratio. A borrower will have a high credit grade if his/her debt ratio is low, and vice-versa.
Maximum Loan-to-Value (LTV)
A LTV ratio refers to the loan amount divided by the appraised value/sales price (whichever is lower) of a given piece of property. A higher LTV usually means that the mortgage lender will be less flexible on his policies regarding a borrower’s credit and debt ratio. A borrower with an A grade will be able to get approved for an 100% LTV loan, and sometimes even 125%, whereas the D borrower maximum LTV typically falls 65-75%.
Getting the Grade
To come to terms with the amount of risk he/she assumes in each individual transaction, a lender uses Fair Isaac Company (FICO) scores. The higher the FICO score, the greater the risk involved. Although there are different bureaus that use their own methods to rate credit, the scores indicate the same risk across the board. Credit scores fall anywhere between 375 and 900 points, and typically a score that exceeds 650 points reveals very good credit. Scores between 620 and 650 points indicate an average FICO score. It is important to note that a lender’s perception of good credit might be slightly different from the aforementioned generalities. Also, not all lenders use a credit scoring system to determine the risk of a loan transaction.
The interest rate that accompanies a loan is set by the lender. The lender’s decision is based upon four major factors. If this four variables are in great favor of the borrower, the lender assigns the loan an A grade. The borrower has in essence qualified for the lowest interest rate available. If one or more of the factors is not up to the lender’s standards, the loan is assigned a grade of A-, B, C, or D paper, depending on the number of questionable factors. D papers generally refer to hard money loans that are based on home equity and not the borrower’s credit.
Since the lender assumes a higher risk with a B, C, or D paper loan than he/she is with an A loan, he/she is compensated by charging a higher interest rate on the lower grade loans. The scale of variance in interest rates among the different grades is inconsistent for these bad credit loans. Be sure to note that by no means are the grades absolute. Do your homework to find the best rate.