What's the connection between your credit score and the interest rate you are quoted on a new home mortgage or equity loan?
More importantly, is it possible that you are being charged a higher rate because your lender doesn't know about--or is intentionally ignoring--something called "Next Generation FICO?"
Here are the answers. To question number one--yes, your credit score can cost you tens of thousands of dollars in mortgage payments. According to a national survey of approximately 5,000 creditors conducted last week by Informa Research Services, home loan applicants with FICO scores of 560-619 were quoted an average 30-year fixed rate of 8.4 percent. Applicants with FICO scores of 720 and up, by contrast, were quoted an average 30-year fixed rate of just 5.94 percent.
(FICO scores are used by most U.S. lenders as a tool to measure the relative risk of default by borrowers. The scores are produced by running credit histories through proprietary statistical software developed by Fair, Isaac & Co, Inc. Generally speaking, the higher your score, the lower your relative risk of defaulting on a loan.)
On a $200,000 mortgage, the higher-FICO applicants would pay about $1,200 a month in principal and interest. Lower-scoring applicants would pay about $1,500 a month for the same mortgage amount. Multiply that $300 differential by 12 and you get $3,600 in higher payments per year--$36,000 over the first ten years of the mortgage--all because of the lower score.
Answer to the second question: You are statistically more likely to generate your highest possible FICO score if your lender or broker is using Fair Isaac's newest and most powerfully-predictive scoring model, called Next Generation.
In a test conducted by the firm, 57 percent of all consumers got higher FICO scores when their credit histories were run through the Next Generation software model compared with their scores on older FICO models. The effect was especially noteworthy for loan applicants on the credit "bubble"--straddling "subprime" credit status versus "prime."
Because of more sophisticated analytical programming built into the Next Generation model, the system is better able to evaluate people who have a couple of credit dings on their files--a late payment here or there, a contested collection account, for example. As a result, according to Fair, Isaac's Karlene Bowen, the new software is "better able to spot the 'goods' (good credit risks) among the 'bads'," and identify people who are solid credit prospects even though they may had some minor problems in the past.
One out of six consumers' scores jump by 50 points or higher when their credit files are run through the Next Generation model. Over a third see their scores jump by 10 to 50 points or more. Those high scores, in turn, can open the door to cheaper mortgage money. Simply moving from a FICO score of 559 to a score of 620 last week, for example, would cut your 30 year rate quote from 8.7 percent to 7.7 percent on average, according to Informa Research Services' survey.
Are many lenders using the Next Generation model to price your loan? No they are not, even though the Next Generation model has been available to them at all three credit repositories--Equifax, Experian and Trans Union--for well over a year.
What's holding them up? Inertia, for one thing, according to mortgage industry executives. Lenders have been racking up record profits and volume from refinances during the past year, and have had little incentive--or time--to convert their underwriting systems to accept the new scores. Moreover, the two dominant players in the home loan industry--Fannie Mae and Freddie Mac--have not pushed lenders to convert, even though the Next Generation scores could turn many subprime, higher-rate borrowers into prime, lower rate borrowers.
Mortgage lenders such as QuickenLoans say they are eager to make the switch as soon as possible, but want Fannie Mae--which buys their mortgage production--to flash the green light. For its part, Fannie Mae says it is still evaluating the new scores, and hasn't decided yet whether to switch to Next Generation itself.