Understanding Credit Scores and Underwriting

The big credit score mystery is finally exposed. Learn how credit scores work and also read up on the mortgage underwriting process.

Mastering the Credit Score: Your Direct Link to Mortgage Interest Rates

In mortgage lending, the credit score is more than a number—it is the primary determinant of risk and the factor that directly controls the cost of your loan. Understanding its components is the first step toward better pricing.

I. The Mechanics of FICO: The Five Key Weightings

Lenders typically use the **FICO Score 2 (Experian), FICO Score 5 (Equifax), and FICO Score 4 (TransUnion)** for mortgage qualification. The middle score is used for single borrowers, and the lower middle score is used for joint borrowers. The score is comprised of five categories with fixed weightings:

35%

Payment History

Consistency in paying bills on time (most critical factor).

30%

Amounts Owed

The Credit Utilization Ratio (debt vs. limits).

15%

Length of Credit History

Average age of accounts and oldest account age.

10%

New Credit

Number of recent credit inquiries and new accounts opened.

10%

Credit Mix

Diversity of credit (e.g., installment loans vs. revolving credit).

II. The Underwriter's View: Beyond the Score

While the score dictates pricing, the underwriting review focuses on specific *events* and *patterns* on the full credit report to assess risk and eligibility.

Trade Lines and Derogatory Events

Mortgage History: Current mortgage accounts are scrutinized for any 30-day late payments within the last 12-24 months. Recent mortgage lates are often instant disqualifiers.
Collection Accounts: Conventional and government loans have different rules regarding open and paid collections. Some loans (like FHA) may require derogatory public records (judgments, liens) to be satisfied before closing.
Judgments & Liens: These are public records that must be addressed. A judgment against the borrower, even if satisfied, may require additional explanation.

Credit Inquiries and Authorized Users

Hard Inquiries: While common, excessive hard inquiries over a short period (typically 90 days) can indicate a borrower is rapidly taking on debt, raising a red flag for the underwriter.
Authorized User Accounts: If a borrower is merely an authorized user on another person's account (e.g., a child on a parent’s card), the debt may be excluded from the borrower's Debt-to-Income (DTI) ratio, provided the underwriter can confirm the primary account holder makes the payments.
Unreported Debt: Any payment obligation not on the credit report but required to be maintained for 10 months or more (like a student loan deferment) must be accounted for in the DTI calculation.

III. The Cost of Risk: Loan-Level Pricing Adjustments (LLPAs)

LLPAs are risk-based fees imposed by Fannie Mae and Freddie Mac (GSEs) based on specific combinations of credit score, loan-to-value (LTV) ratio, and property type. These fees are the primary reason a lower credit score results in a higher interest rate or higher origination fees (discount points).

LLPAs are expressed as a percentage of the loan amount (e.g., 0.500% or 1.500%). The lender can choose to charge this fee as an up-front cost (points) or take the fee as compensation in exchange for quoting a higher interest rate. **The lower the FICO score and the higher the LTV, the greater the LLPAs.**

Example of FICO Tiers and Cost Impact

A conventional loan with a 20% down payment (80% LTV) illustrates the direct cost impact:

FICO 740+ Tier: Minimal to Zero LLPA fees, resulting in the best possible interest rate.
FICO 700-719 Tier: Moderate LLPAs (e.g., 0.500% to 1.000%) requiring the borrower to pay slightly higher points or accept a slightly higher interest rate.
FICO 620-639 Tier (Minimum): Significant LLPAs (e.g., 2.500% or higher). The added risk results in much higher costs, often making the difference between an affordable and an unaffordable monthly payment.

Credit Risk Analyzed. Time to Tackle Income.

Now that we've covered the nuances of credit, the next major hurdle in underwriting is income. We will move to a deep dive on complex income streams and the critical DTI calculation.

Move On to Module 7: Advanced Income and Employment Documentation →