Is It Wrong to Do the Right Thing?

WASHINGTON--In a misguided attempt to improve their credit scores, too many mortgage borrowers are taking steps that end up doing more harm than good.

Among other blunders, they are paying off judgments when they don’t have to, closing out old accounts they shouldn’t, opening up new ones and unnecessarily consolidating their credit cards. While all of these strategies seem like sound ways to upgrade your borrowing position, any one of them is more likely to have a negative impact on your score.

So will surfing online for the very best rates available, trying to improve on a score that’s already good enough to obtain the rate you are after and opening up new accounts after you’ve been approved for the mortgage.

In all of these cases, said Ginny Ferguson, a mortgage broker in Pleasanton, Calif., timing is everything. Why? Because a credit score is simply a snapshot of your credit profile on the day it is calculated. Three days from then, it could be totally different.

Much of what Ferguson, chairwoman of the National Assn. of Mortgage Brokers’ credit-scoring task force, has to say is contrary to popular wisdom. But she said that in many instances, “consumers are being given bad information that can be extremely detrimental to their credit scores.�

For the uninitiated, a credit score is a numerical, computer-generated statistical grade that quickly and objectively evaluates the information in your credit profile. It is often referred to as a FICO score, after the company that originated it, Fair Isaacs & Co. But only one of the three major credit repositories actually uses the FICO model; the other two have their own software programs. Mortgage companies and secondary market investors have been using scoring for years now because it increases their ability to determine their risk on each loan. They use the predictive power of scoring to weed out the slow or bad payers and decide who pays less, who pays more and who doesn’t qualify at any rate.

A loan applicant’s score isn’t the only determining factor. Such considerations as income, how long he or she has been on the job, location of the property, down payment and cash on hand are important too. But it is a key piece of the puzzle, so it behooves anyone who is in the market for a house to go over their credit files carefully at least 90 days before applying for a loan.

Applicants should take steps necessary to correct mistakes and expunge incorrect information. Pay off any and all current late accounts right away. “Right now, past dues are killers,� said Ferguson, a former real estate broker. “They will submarine you, so paying them off will have an immediate and positive impact� on your score.

Beyond that, though, proceed cautiously. You don’t want to pay off any judgments or collections that are at least 24 months old. Not only is this “unlikely to get you where you want to go,� Ferguson warned, it could turn an old problem the scoring software views as insignificant into a new one the program sees as much more serious. Why? Because scores are based on the last day of activity. So if you pay off a 5-year-old credit problem, it automatically becomes a “yesterday event� that will have a much more profound (read negative) impact on your score.

If the lender requires you to pay off old “derogatories,� as they are called, Ferguson suggested doing so at closing, not before. Otherwise you take the chance the payoff could be counted against you. Even if you act after you’ve been approved, it could have a negative impact because, for quality-control reasons, some lenders run a new credit report a few days before settlement. If that happens, the new entry could lower your score. That’s the same reason you don’t want to open any new credit accounts before closing. Even if they have a zero balance, new accounts will drop your score. How much depends on what else is in your profile and how the 40 different variables the software looks at stack up against one another. But even a few points can impact the price of the loan or the type of loan for which you qualify.

Be careful about consolidating debt and closing credit cards. Missteps here could give the system the wrong impression about how you use credit. “Don’t consolidate,� Ferguson said. “It could send your score into the basement.� The reason: The number of sizable outstanding balances is predictive of risk, as is the proportion of those balances to the total credit limit.

It is better to have five credit cards, each with $5,000 limits and four with $1,000 balances, than to consolidate all that into a single card with a $5,000 limit and a $4,000 balance. When you are only using 16% of your available credit, the system sees you as self-disciplined and low-risk. But when you are using 80% of your available credit, you’ve changed the picture entirely. “From a risk perspective, who would you loan to?� Ferguson asked. “You’ll get far more mileage out of paying your available balances down to 30% or less of the credit available to you than you will by paying off some cards and leaving others maxed out.�

The length of time you’ve had credit can be critical too. A short history is indicative of risk, especially if other negative factors exist. If you transfer the balances from accounts you have had for three, four or five years into a brand new account, even one carrying a lower interest rate, you no longer have any longer-term credit to evaluate.

Scoring models “don’t like limited credit histories,� said the scoring expert. “The longer you’ve had credit, the more time there is to analyze. If you’ve had credit for only a few months, the system won’t know how you are going to perform. Therefore, a seasoned file is going to score higher.�

Models aren’t crazy about lots of credit inquiries, either. Multiple inquiries contribute less than 10% of the weight of a score, depending on what else is in your file. Ordinarily, inquiries alone will not lower a score dramatically. But timing is key. Multiple requests by auto dealers or mortgage companies made within a 14-day period count as one inquiry. But quality-control inquiries and all others older than 30 days before the date on the current report will have an effect.

Which is why you should be “very cautious� of surfing the Internet for a loan, Ferguson said. “You can look all day long. But the minute you authorize an online lender to pull your credit report, you are creating an inquiry� that could count against your score, she said. Finally, if your score is high enough to obtain the rate and terms you are after, leave well enough alone. “If it’s not broken, don’t fix it,� Ferguson said. “Even if you think your score should have been higher, don’t try to fix it in the middle of the lending process. Wait until after the fact; otherwise, chances are good your score will go down, not up.�

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Lew Sichelman is a syndicated real estate columnist. He can be contacted via e-mail at [email protected]. Distributed by United Feature Syndicate.