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The first thing you hear from almost any source when you start to think about building a new home is to check your credit score. Most prospective home buyers then head to websites like myFICO or Credit Karma to get their credit score. For some, this may be the first time they have actually ever seen their credit score. The big day comes to apply for a construction loan to build a custom modular home and then it hits them. The score the construction loan lender says they have is very different than the one they accessed on one of the popular websites. How can that happen?
Some Credit Score Basics: FICO or VantageScore
There are two main scoring systems for credit. The original and well known one was developed by the Fair Isaac Company, now shortened to FICO. The company specializes in predictive analytics. They are experts at taking information from the three credit reporting bureaus and predicting which accounts will pay their bills (or not), file for bankruptcy, and who can handle a larger credit limit. Until 2006, FICO had no real competition. They were the standard credit scoring company.
In 2006 the industry of credit scoring became competitive when the three major credit reporting bureaus; Experian, TransUnion and Equifax got together and jointly developed an algorithm to produce a new score – the VantageScore. VantageScore is the score used by the popular credit site Credit Karma.
Remember, there are three credit bureaus. Each one uses its own data in calculating the score, so you will have three different scores for FICO and three different scores using the VantageScore algorithm. VantageScore has started to get many lenders’ attention and it is widely offered to consumers for free.
The Credit Score Mortgage Lenders Actually Use
Whether you go to Credit Karma (which uses VantageScore) or pay for your FICO score (or get access through a credit card company) you are really only getting an “educational” credit score. These scores will provide you with a perspective on your credit standing. They probably aren’t the scores that your lender will actually use to approve your credit application.
When you try to borrow money; whether it be for a new car, a credit card, or a home, the lender will typically pull a credit report. Depending on the purpose of the loan, the lender may be using a FICO or VantageScore to evaluate your credit worthiness. When consumers get a score, they will see the standard version of it. FICO is on version 9 of its scoring model and VantageScore is on version 3.
What most people don’t know is that FICO, the company that has owned the credit scoring industry for years, has dozens of specific algorithms and scores for many industries. If a lender that offers car loans pulls a credit report it is most likely using the version of the credit score that predicts how well you pay your car payments. If you are getting a credit card, the credit card company is requesting a credit score using the model that best predicts how well you will pay your credit card bill.
It is the same with home mortgages. While version 9 is currently available, FICO model 8 is the one in general use. However, mortgage lenders are required by law to use FICO 4. It’s the only tool to evaluate credit risk that is approved for use by government-sponsored enterprises such as Fannie Mae and Freddie Mac (the government backers of most home mortgages). FICO 4 came out in 2004. What this means is the FICO score you get from any source won’t match the score your mortgage lender uses because of the way it evaluates information on your credit report.
How Can I Improve the Score My Lender Uses?
While it may sound complicated with multiple credit bureaus, multiple credit score companies, and multiple credit score models, the basics of keeping a good score are still the same. Pay your bills on time, keep your credit card balances low, and manage your debt.
Several years ago a report by the Federal Trade Commission found that 21 percent of a representative group of American consumers discovered a “confirmed material error” in at least one of the credit reports issued by one of three credit reporting bureaus. Everyone is entitled to a free credit report from each bureau every year (free at Annualcreditreport.com). It is a good practice to get yours and evaluate it for errors. Errors can take time to correct. The worst time to find an error is when your mortgage lender pulls your credit score when you are ready to start building your new custom home!
There are things that can even hurt your score that many don’t think about:
- Cosigning for a loan or credit card for someone else
- Closing credit card accounts
- Old, Unpaid Medical Bills
- Not using credit cards at all
It is important to have a well-rounded credit picture for most credit scoring models. The overall objective of credit score models is to predict, for the lender, what is the likelihood that you will make your payments on time and that you will ultimately pay back the entire debt. They usually want to see some history of installment loans (i.e. car payments) and consumer borrowing (i.e. credit cards). While it is nice to live debt free, lack of a credit history is almost as bad as a bad credit history.
Getting Qualified for Your Modular Home Construction Loan
If you are going to pay for a credit score, buy your FICO Score. It is the one that will most closely model your actual credit score when you begin to shop for a mortgage. However, if you are just trying to monitor your credit score over time and have access to a free VantageScore score, that information can help you stay tuned to changes that can occur.
While the credit score you see won’t match that of your lender, your goal is to present the best credit score you can to your lender. A good score will get you qualified for your new home construction loan at the lowest rate and best terms. Start today by getting your free credit reports from the bureaus and learning what your current scores are as you pursue the dream of building your new home.
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