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How mortgage lenders grade borrowers

Applying for a mortgage is like taking a final exam: You earn a grade. A lot of money rides on the grade you get on your mortgage.

If you get an A, the lender will quote you its best rate and terms. An A-minus might cost a little more in rate and fees. A grade of B is pricier still, and C costs even more. You don't want to make a D.

As for the lowest grade, E, hardly anyone sinks that low. Lending money to someone with an E grade is like fronting matches to a convicted arsonist with a gasoline can in one hand, a wad of rags in the other and a crazed gleam in his eye. Whatever you lend is probably going to go up in smoke.

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Making your grade
Your grade depends on a number of factors, including your:

  • credit score (a number between 350 and 900 that reflects your creditworthiness);
  • debt ratios (percentage of before-tax income that will go toward the mortgage and toward all debts, including mortgage);
  • loan-to-value ratio (the amount borrowed as a percentage of the cost of the home);
  • recent payment history.

Every lender grades a little differently. A lender has a chart, called a matrix, that helps the loan officer determine your grade. Using your credit score as a starting point, the lender assesses your payment history and your ability to repay (by looking at the debt and loan-to-value ratios) to arrive at your grade.

Recent payment history is the most important factor because it is counted twice. First, your payment history affects your credit score. Second, lenders grade you harshly for late payments on mortgages, credit card and other debt payments in the past two to five years. A payment is considered late if it is paid more than 30 days past the due date, so an occasional payment 10 days past due won't count against you.

A is for approved
A borrower with an A grade typically has a credit score of at least 620 and has had no late mortgage payments in the past two years. Some lenders might let one late credit card or auto payment slide in the last 12 to 24 months.

Someone with an A-minus score might have a good repayment history but a mediocre credit score because of high loan balances or a short credit history or other factors.

"There's no exact number that defines the credit score of an A-minus borrower. It's a range that depends on a number of factors," says David Motley, executive vice president and loan production manager for Colonial Savings in Fort Worth, Texas. That said, a rough range for typical A-minus borrowers would be a credit score between 580 and 620.

An A-minus borrower typically would be charged a higher rate or fees, or take out additional private mortgage insurance. It wouldn't be uncommon for an A-minus borrower to be quoted a rate of 1.25 to 1.5 percentage points higher than someone with A credit.

Anything below A-minus is considered a subprime loan. In addition to paying higher interest rates, subprime borrowers often pay heftier fees at closing, higher late-payment fees, prepayment penalties and credit life insurance so that the bank gets paid if the borrower dies. Banking isn't a business for sentimental types.

B is for bigger rate
A borrower with B credit generally has a credit score between 550 and 580 and two to four late mortgage payments or a couple of late car or credit card payments in the past year. No payments were more than 60 days late.

"Again, there's not a hard-and-fast level of credit score that defines A from B, but rather it's a combination of factors and circumstances that exist for each borrower," Motley says. And there are gradients within the grades, often corresponding to the loan-to-value ratio. Some lenders might refer to B-plus, B and B-minus borrowers; others might call them B, BA, BB and BC.

A mortgage borrower with B credit could expect to pay a rate of 1.75 to 2.75 percentage points more than someone with A credit. This is a really rough estimate and there are a lot of exceptions -- much depends on the loan-to-value ratio. Someone borrowing 55 percent of the house's value will get a better rate than someone borrowing 75 percent.

Below the B grade, credit score isn't as important as recent payment history. People with C credit have made three or four late mortgage payments in the past year, and one or two of them might have been between 60 and 90 days late. A C borrower has a pattern of late payment on auto loans and credit cards, and can expect to pay rates in excess of 3 percentage points more than someone with A credit.

The risk of lending to B and C borrowers is that they might not understand the terms of the loans. That's part of the reason that 97 percent of Colonial's loans go to A-rated borrowers. "Lots of times, borrowers are in these lower-rate credit score areas because they're not as sophisticated," Motley says. "They didn't know all the consequences of their failure to make payments."

Other times, he adds, bad things happened to these borrowers, such as poor health or extended unemployment.

Going further down the scale, a D borrower has a terrible payment record, frequently paying 60 or 90 days late and occasionally 120 days late, and can expect to pay a rate of 4.5 or more percentage points higher than someone with A credit.

An E borrower might have declared bankruptcy recently, or had a house foreclosed upon. Few lenders would bother with an E borrower, and when they do, rates are sky-high.

 

 
-- Posted: April 18, 2002
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See Also
10 do's and don'ts for getting a great mortgage
Why your mortgage may cost more
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