The Great Mortgage Correction III
September 19th, 2007 Categories: Mortgage News
The Credit Crunch…another new politically correct term being thrown around like a baseball nowadays in the mortgage news.
What is it? A few things…One, it constitutes a stricter consideration to whats actually reporting on a consumers credit bureau, rather than just the score (not all 650’s are equal). Debt to high credit ratios, aging of accounts, type of accounts all figure into a comprehensive review of a credit bureau. Two, a raising of the bar so to speak, one that requires higher scores (than before) to access certain mortgage programs.
Why is it happening? Banks have less money to lend. Wall Street has alot to do with this in the sense that if say (arbitrarily) CountryWide had it’s portfolio downgraded/devalued, they would lose some ability to lend out money. (The amount of money a bank lends is related to how much depositor money they currently have). This is why BofA invested $2B in CWBC…its not that Countrywide wouldn’t lend out additional money, it really couldn’t under banking regulations.
Credit scoring is based on an specific algorithm that crunches a bunch of numbers and factors them into an equation that yields a number between ~350-~850 (both numbers are theoretical). Whats interesting is that (not so) Fair Isaac won’t tell anyone what the secret formula is. They give general clues and nice pie-charts so sound assumptions can be made, but what is the down low dirty-dirty?
There is plenty of material out there regarding how credit scoring models work, e.g. to close or not to close an account, high credit limits vs current balances, length of time accounts are open, etc etc…Here’s where we deviate from the norm with some thoughtful questions…
What credit score is most appealing to a bank (not a mortgage broker/banker) from a business standpoint? A) 640 B) 680 or C) 710
If you said A, pat yourself on the back. I imagine most would guess C, after all don’t lenders look for good credit borrowers? Well, yes and no. The 710 borrower is likely to be someone with a high personal finance IQ, these people often demand and receive the lowest rate and cost. The 640 borrower will have to accept a higher rate and cost ‘because their score is only a 640′. Higher rate and cost equals higher profits for the bank. Mainstream media has engorged the airwaves with news of lenders pushing borrowers into higher cost products, so this theory isn’t too hard to digest.
Would it be wrong to suggest that lenders would rather see someones FICO score drop rather than rise…further, would it be below them to engage in practices that insured this happend? I don’t think so, but thats just me.
Consider for a moment though, credit card companies have the right to reduce your available high-credit limits for (almost) any reason under the sun…For example:
Most credit cards have in their policy docs (the fine, fine print) that they have the right to ‘adjust’ your account if you are one (1) day late, not 31 days, 1 day. Lets say you receive your bill and send off the payment but the credit card company has changed their mailing address, which happens with greater frequency than you may believe. By the time your payment is rerouted and processed it is officially over 1 day late. Bingo, they can adjust your account. If you happen to be 30 days late on any other account reporting to the bureaus, they can ‘adjust’ your account. An erroneous medical (or other) collection pops up, a creditor mis-reports the status of an account, you change your address, your profession, close out an account…any of the above can trigger the loss of FICO points. When (not if) this happens your are subject to a whacking.
Consider the Census data that states the average credit score for someone with 0 late automobile payments is a 703, those with 1 late payment have an avg score of 605…98 points. Thats the difference between A+ and sub-prime in todays mortgage world. It could be the difference between approved and denied.
What happens to your 660 credit score if you have a credit card where you owe $3000 and has $7000 high credit limit ‘adjusted’ to $4000? Yup, it sinks, which is bad enough until you consider the domino effect.
Since your score has dropped (say 10 pts), your other credit sources are very likely to do something similar, to which they’ll then politely tell you that your rate has gone up too (since your score dropped, dummy), causing an overall score drop of ~30 pts, down to a 630 Let’s take it one step further and say you’re four years and nine months into a 5.25% 5-Yr ARM…
The dilemma is glaringly obvious and you’re about to pay through the nose for it, the scary part is you may have had no control over the circumstances, and even worse you probably wouldn’t find out until it’s too late.
It’s more like a credit punch than a crunch.
Well, I was going to go into some long term suggestions to make sure this type of correction doesn’t catch consumers off guard again, but this post has run long enough. So I guess it’s now officially a 4 part series…
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