|How mortgage lenders grade
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.
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.