Chapter 16: Why You Shouldn’t Cry Over Credit
Your credit score is NOT as important as you may think when buying a home using your VA Home Loan Benefit!
Are you concerned about your credit score and if it may disqualify you from getting VA financing for your home purchase? If so, you are not alone.
So Cal VA Homes, the innovator of VA home ownership processes and programs, does not want you to worry about your credit score! Surprisingly, your credit score may not be nearly as important as you might think, especially as it relates to VA financing. Many people are uncomfortable with the idea of a credit score. It sometimes feels like the adult version of being graded in school. For some, a credit score is like an invisible force hovering out there somewhere just waiting to judge you and destroy your dreams.
But credit scores are merely a way for lending institutions to try and predict future behavior. Credit scores are an attempt to create, via statistics, a magic crystal ball of sorts to gauge your ability to repay a loan.
Your credit report contains lots of information including:
Credit risk scores, typically from Fair Isaac Co. – “FICO” scores.
The consistency of how you pay your bills.
Which bills you’ve missed or paid late.
The types of credit that you applied for (inquiries regarding mortgage loans, auto loans, consumer financing, installment payments, revolving credit).
Your payment history on each type of loan including the capacity or limit of a particular piece of revolving credit, as well as how much outstanding balance you have relative to that limit.
Any current debt amount you may hold.
Who you are paying.
When the account was opened.
Whether it is still open.
Whether you have any delinquencies.
Whether the delinquencies are 30 days late, 60 days late, or 90 days late.
When the late payments occurred.
Whether you’ve gone into foreclosure on a particular mortgage.
Whether the account is current now.
Whether it’s joint with you and your spouse.
If it is an individual account.
Any judgments or levies filed against you.
This very personal information is gathered by the major credit bureaus and then sold in formatted packages—primarily a credit report—to companies who (hopefully) want to extend you credit (such as an auto lender, mortgage company or a credit card company.) In short, your credit score seems to include most all of your personal information except your shoe size.
The Credit Risk Score was developed by Fair Isaac and Company (FICO) to assist financial companies in assessing risk. It may or may not bother some people to learn that Fair Isaac and Company is a private, for-profit company, not a governmental oversight department. There are two government agencies who provide oversight for credit bureaus: the Federal Trade Commission (FTC) and the COC (Comptroller of the Currency). Still, it may be jarring for some to know your personal data, your score, is purchased by a company in order to make a decision whether or not to issue you credit. Typically, lenders subscribe to the three main national credit bureaus, which are:
Everything that is reported gets aggregated by the bureaus to produce your score(s). We assume at this point that some readers have gone sheet-white over the fact that your personal details are given the “Big Brother” treatment. You might also have paled from sheer stress, wondering what “number” you are given by the software analytic powers that be. STOP WORRYING!
As stated before, active military and Veterans have a specific advantage: VA financing criteria is really, really liberal in terms of the “credit quality” that VA underwriters will accept. The reason for their liberal credit underwriting guidelines is because the VA underwriters and their lenders have the backstop of the VA Guaranty—insuring up to 25% of the loan balance, backed by the U.S. government. This allows underwriters to accommodate credit scores that conventional guidelines would often deem too low. FICO scores range from 300 to 850, and conventional loan underwriting prefers credit risk scores of 700 or better. Yet, with the VA Guaranty of 25% of the loan balance - the government-backed insurance pool – much lower scores, as low as 500 might be considered. The bottom line is, if you have marginal credit…in the “fair to poor range,” YOU CAN LIKELY STILL BUY A HOME!
Given this VA advantage, you can reconsider your credit risk scores. Is it really important to have high scores? In terms of qualifying for VA financing, the answer is No.
If you have previously determined to hold off from trying to buy a house because you thought your credit needs to improve, then you simply haven’t properly evaluated your situation. There is hope!
That doesn’t mean your credit report (a document that shows your credit history and scores) can be a disaster (e.g., you can’t have a credit history filled with charge-offs, delinquencies and collection accounts and expect to be approved for a loan.) You need to work to keep your financial house in order. But if you had, for example, a bankruptcy or a life event such as an illness, and you resurrected yourself from all your crises and saved your credit profile, you are likely still able to get a loan or credit extended to you.
Let’s explain this concept with some numbers. (We’ll keep the Wall Street gibberish to a minimum.) Say a person with a credit risk score of 600 is offered a rate that would be approximately 3/16th higher than a borrower who had “superior credit” or a 740 score. Well, 3/16th isn’t even ¼ of 1%. (It’s just slightly higher than 1/8th.) And someone who had credit risk scores between 620 and 660 might be offered a rate that is 1/8th of 1% higher than someone who had superior credit risk scores of 720 or higher. Both of these lower credit risk score profiles are getting offered pretty good rates, all things considered.
Such is the difference between loan offers for lower credit scores, with the involvement of the VA Guaranty. Got a credit risk score of 600? That’s not a great score but you can still get a good loan, thanks to your service and the VA Guaranty. The VA Guaranty, facilitated by the “VA Funding Fee,” the money that goes into the “Guaranty pool” is the huge benefit that makes the whole thing work.
The reason we are telling you about the importance (or lack thereof) of credit score is to give the you, the VA buyer, a more complete picture of what you are up against…and where you can catch a break. People may be discouraged by their credit score and think that they need to improve it before they can pursue homeownership. If you are holding off trying to buy a house because you think your credit needs to improve, you may be shooting yourself in the foot! VA financing is likely already available to you with competitive rates. Those thoughts that your credit needs to be better are more applicable to conventional underwriting on conventional loans.
Here is where the VA Guaranty comes in, which is your green light to pursue a loan and ultimately own a home, regardless of your credit score. Let’s say you decide to wait for the perfect moment when you have improved your credit score to a traditionally good score of 700+. Okay, but what if during that time of improving your credit, interest rates rise 1% and prices go up 10%? Your ability to afford a property is dramatically affected, and the payment for the same house is now approximately 23% higher. The chance to purchase that house may just have slipped through your fingers. Big mistake!
The VA Guaranty is the lender’s “risk adjustor” that allows them to take a risk on you. Statistically, VA loans default at a rate much higher that of their conventional loan counterparts. The VA Guaranty of 25% dramatically reduces the lender’s risk of loss, in the same manner that a 20%-25% down payment reduces the risk for the conventional lender. Essentially, the VA Guaranty absorbs the risk that is comparable to the typical down payment. Advantage Veteran! Don’t make your credit blemishes an excuse to defer considering purchasing a home. Again, that would be a mistake.
Hopefully you now understand why we CAN make the statement, “Credit scores are NOT that important!” They have only a marginal effect on the rates available to VA loan applicants. Because the VA program is the lending marketplace’s credit risk equalizer, it eliminates the necessity of superior credit that is required for conventional financing.
Finally, don’t rely on credit risk scores that are generated anywhere other than an application for a mortgage loan. These credit risk scores are derived from the FICO score “software versions” necessary for a mortgage application. The credit reports will generally produce two to three credit risk scores. Consumer credit monitoring systems use different FICO software versions, typically producing a single score. Again, this score can be dramatically different than those scores obtained by mortgage lenders. Relying on your credit monitoring system’s single “consumer version score” can be very misleading when it comes time to apply for a mortgage. There can be a big difference in the single consumer score vs. the “middle score” of the three scores produced by a credit report for a mortgage application. This could potentially create a false sense of security for you if you are only using these “other scores” as your credit monitoring measurements.
For assistance in discovering your scores and viewing your entire credit report, let So Cal VA Homes help. Call us at (949) 268-7742.
Call a Sr. VA Home Loan Technician today!