The Best Kind of Loan for Your Credit Score.
I’m often asked if having certain types of credit or loans is better or worse than other types of credit or loans.
I get questions like, “John, is it better to have a car loan
or a mortgage for my scores?” I also hear, “John, is it better to have a secured card or an unsecured card for my scores?”
In fact, you can swap in almost any type of credit-related account and I’ve been asked about that scenario.
I’ve been getting this type of question for almost 15 years now, and it seems that people believe there’s value or a penalty for having certain types of loans or accounts on your credit reports. That’s completely understandable and, thankfully, almost a complete myth.
First, let’s tackle the secured credit card, versus the unsecured credit card, versus the charge card question. The assumption is that the type of card has a direct impact on your credit scores. That’s an incorrect assumption, meaning, you’re not penalized or rewarded for having one type of card over another.
That doesn’t mean one form of plastic isn’t better or worse for your credit than another. For example, a secured credit card is easier to max out than an unsecured credit card.
Why? The reason is because secured cards have considerably lower credit limits than unsecured credit cards. It has nothing to do with the fact that one is secured and one isn’t. It has everything to do with the credit limits.
When it comes to installment loans, the issue of credit limits disappears because installment loans don’t have credit limits. They do, however, have original loan amounts.
An auto loan is likely to have a considerably lower loan amount than a mortgage, home equity loan and perhaps even a student loan. And, balances do matter on installment loans, albeit slightly.
Exactly like credit cards, credit scores do not treat installment loans of one variety or another differently. The collateral issue of balances can cause variable score impact, however.
One thing we haven’t addressed yet is the issue of missing payments and defaulting. Defaulting on a credit card, secured card, charge card, auto loan, mortgage, or any other kind of credit card, is treated equally — as one default.
You’re not penalized because you’ve defaulted on one variety of credit account versus another. You can, however, have a much larger default amount on a mortgage than any other type of credit account and that’s where the score impact can be variable.
The bottom line is: it’s not really the type of account that’s important, but it’s the incident that matters.
There is one very small exception to this rule. In fact, it’s so small that I thought very hard about omitting it.
There’s a chance your score could be negatively impacted if you have too many finance company accounts on your credit reports. These are the loans offered by consumer finance lenders who often target the near or subprime consumer.
Notwithstanding the consumer finance issue, the lender is also meaningless in your scores. So, you don’t get rewarded for doing business with a large, well-known credit card issuer and you don’t get penalized for doing business with a subprime credit card issuer.
In fact, credit scores are brand agnostic when it comes to your credit accounts. The most important factor is how you manage them.
Editor’s Note: This article by John Ulzheimer was originally published on MintLife.
See more from Mint.com:
FHA Announces Important Guideline Changes.
Mortgagee Letter 2012-3 announces several key guideline changes on topics of self-employment, disputed credit, outstanding collections and identity of interest definitions. These changes are good from the perspective that they offer much clearer underwriting requirements on several key topics so not as much is left to interpretation or opinion. All of these changes are effective for cases assigned on and after April 1st.
Topic: Self-Employment
New Requirement for AUS Approve/Accept & Manual Underwriting: A P&L and Balance Sheet is required if more than a calendar quarter has elapsed since date of most recent calendar or fiscal-year end tax return was filed by the borrower – with no exceptions. Additionally, if income used to qualify the borrower exceeds the two year average of tax returns, an audited P&L or signed quarterly tax returns obtained from IRS are required.
Topic: Disputed Credit Accounts
New Requirement: AUS Accept/Approve does not need to be downgraded to a Refer and manually underwritten as long as
• the total outstanding balance of all disputed credit accounts or collections are less than $1,000, and
• Disputed credit accounts or collections are aged two years from date of last activity as indicated on the most recent credit report.
If the borrower has individual or multiple disputed credit accounts or collections with singular or cumulative balances equal to or greater than $1,000, the accounts must be resolved (e.g. payment arrangements with a minimum three months of verified payments made as agreed) or paid in full, prior to, or at the time of closing. The payments arranged for the accounts must be included in the calculation of the borrower’s debt-to-income ratios.
Disputed credit accounts or collections resulting from identity theft, credit card theft, or of unauthorized use, etc., will be excluded from the $1,000 limit under the terms shown below. The mortgagee must provide a credit report or letter from the creditor, or other appropriate documentation, to support that the borrower filed an identity theft or police report to dispute the fraudulent charges. Mortgagees must provide documentation in the case binder to show all disputed or collection accounts are resolved, verified as not a debt to the borrower, arrangements made for payment, or paid in full.
Topic: Outstanding Collection Accounts & Court-Ordered Judgments
New Requirement: If the total outstanding balance of all collection accounts is equal to or greater than $1,000 the borrower must resolve the accounts (e.g. entered into payment arrangements with minimum three months verified payments- paid as agreed) or paid in full at the time of, or prior to closing. If the total outstanding balance of all collection accounts is less than $1,000, the borrower is not required to pay off the collection accounts as a condition of mortgage approval.
Note: Paying “down” of balances on disputed accounts and collections to reduce the singular or cumulative balance to below $1,000, is not an acceptable resolution of accounts.
An exception to the payoff of a court-ordered judgment may be made if the borrower has an agreement with the creditor to make regular and timely payments, and provides documentation indicating that a minimum of three months payments have been made according to the agreement. The monthly payment must be included in the borrower’s debt-to-income ratio.
Topic: Identity of Interest Transaction
New Requirement: The definition of a family member for establishing “identity of interest” purposes has been expanded to include a child, parent, grandparent, spouse, legally adopted son or daughter, including a child who is placed with the borrower by an authorized agency for legal adoption, foster child, brother, stepbrother, sister, stepsister, uncle, and aunt.
Please be sure to read the Mortgagee Letter in its entirety.
Buying a Home/U.S. Department of Housing and Urban Development (HUD).
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THE increased cost of F.H.A. mortgages has shifted the math a bit for would-be borrowers.
A home buyer with a down payment of less than 20 percent generally has to pay up in some other way to ensure that lenders are protected against default. (This requirement slipped during the housing boom; see “financial crisis.”)
The most popular low-down-payment loans have been those insured by the Federal Housing Administration. Borrowers can make down payments as low as 3.5 percent; they pay an upfront fee (often rolled into the loan) and a monthly premium. An alternative is private mortgage insurance, or P.M.I., available to those who put down at least 5 percent.
As the name implies, the insurance is provided by a private company rather than the government. Premiums can be paid up front, each month, or in a mix. The amount of the premium drops as the size of the down payment rises. Use of these loans has fallen off sharply in recent years as the P.M.I. companies tightened standards and F.H.A. gained popularity.
Effective on April 18, F.H.A.’s annual premium on a 30-year loan rose to 1.1 or 1.15 percent of the loan value, up from 0.85 or 0.9 percent. (The higher rates are for down payments below 5 percent.) On a $400,000 loan with the minimum down payment, that’s $83 more per month.
The monthly fee is in addition to the up-front premium, equal to 1 percent of the loan value. Which loan to go with may depend on the answer to a question: “how long is it going to take to recoup that 1 percent up front?” said Matt Hackett, an underwriting manager at Equity Now, a direct mortgage lender based in New York.
In the first quarter, 17.7 percent of new loans were F.H.A., according to Inside Mortgage Finance, an industry data provider, while P.M.I. had a 5.4 percent market share. Applications for F.H.A. loans jumped 20 percent in the month preceding the price increase, then tumbled when it went into effect, according to the Mortgage Bankers Association.
In addition to lower minimum down-payment requirements, F.H.A. has laxer rules for credit scores and debt-to-income ratios. Right now, it also has lower interest rates, said Thatcher Zuse, the president of Sound Mortgage, a lender and broker in Guilford, Conn. “Almost as a rule, as the rates stand right now, the less equity you’re putting down, the better the F.H.A. deal becomes.”
Mr. Zuse ran the numbers for two buyers able to put 5 percent down. For a buyer with a 780 credit score, the cost difference between F.H.A. and P.M.I. was negligible, but a buyer with a 650 score could save about $200 a month on a $400,000 F.H.A. loan.
There are circumstances peculiar to the New York area that could push a borrower to F.H.A., said Robert Donovan, a Bank of America senior vice president and regional sales executive. For one thing, the region has a high concentration of two- to four-unit homes, popular with buyers who want to live in one apartment while renting out another. Loans in such cases are treated much more liberally by F.H.A., he said.
The same goes for new-construction condominiums of any size: until more than half a project is sold, conventional loans may not be an option. F.H.A.-backed loans are available even if as little as 30 percent of the project is sold, Mr. Donovan said.
In the broadest terms, for someone with no special circumstances, great credit and a more-than-minimum down payment — say, 10 or 15 percent — P.M.I. may turn out to be the better deal. Someone with weaker credit or less cash may find F.H.A. works better.
To generalize, “if you qualify for P.M.I.,” Mr. Hackett said, “you should usually choose the P.M.I., because it is going to be less.”
Circumstances vary, though, so ask any lender to produce a written comparison, said Michael Moskowitz, the president of Equity Now, “just to keep the lender honest.”
Current Mortgage Rates in KY: Louisville Kentucky today’s mortgage rates 04/30/2011.
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