Your credit score risk factor

Minneapolis, MN: We all have credit scores, but do you know what your credit score tells creditors? It tells us your credit risk, and likelihood of the money not being paid back. 

Of course a high credit score is no guarantee of being paid back, just like a bad credit low scores are not a guarantee of default, but creditors have plenty of historical data to give us an idea.

Most lending is based off  what is know as 'risk based pricing', which simply means the lower your credit score, the higher risk of default, and the higher interest rate you pay for that risk.

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More Than Just A Credit Score

Other factors can come into play to help a lender mitigate risk.

Amortization period. For example, a 15-year loan is a lot less risky than a 30-year loan

Loan-to-Value (Down payment size). A smaller down payment is significantly more risky than a large down payment.

So someone with a lower score, but putting a bigger down payment selecting a 15-year loan might get a loan approval, while someone with the exact same credit score using a small down payment and a 30-year loan might get denied.

The 5 C's of Credit

The basic framework for understanding, mitigating, and measuring risk are known as the 5 C's.  Here is what the 5 C's mean:

Character

What kind of person are you?  Do you have a long documented credit history?

Capacity

This is about your ability to take on debt, also known as debt-to-income ratio's.  Someone successfully paying rent for $2000 a month for years has documented the capacity to pay a $2000 a month mortgage payment. Someone who has lived rent free, and now suddenly has a $2000 a month house payment would suffer from 'payment shock'.

Capital

This is generally defined as overall wealth. How much money do you have saved, how much will you have after down payment.  Clearly someone with plenty of money left in the bank for example has the ability to make payments for awhile if they had a job loss, whereas someone living month to month would immediately be in trouble.

Collateral

In mortgage lending, this is the house itself, and very important. Lenders like traditional homes that are easy to resell if something were to happen, and why getting loans on fixer-uppers, and odd homes, like a berm or log home are more difficult.

Conditions

This one is more about the overall picture, and the purpose of the credit.  In mortgage lending, a good example is the difference between an owner occupied home, and a buying a rental property.

The Bottom Line

As you can now see, there is a lot more to getting a home loan than just your credit score, but also how important credit scores are, as well as your overall picture and profile.

If you are thinking of buying or refinancing a home, our experts here at Cambria Mortgage, the Joe Metzler team are happy to provide a no obligation application review, along with a softpull credit report, which has no impact on your credit score.

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