Credit Questions & Answers

So you’ve got a question about your credit? Send it in to questions@equidash.com

Every now and then, we’ll pick one of the questions we receive and respond to it here in our Credit Q&A section!

Q: How long will my Chapter 7 Bankruptcy stay on my credit report?

A: Generally bankruptcies remain on your credit report for a period of 10 years, making them one of the most devastating negative items you can obtain on your report, both in the negative impact that they have on your score as well as their relative longevity compared to other items.

Home >> Credipedia >> F >> FICO 08

FICO 08

Definition: a revision to the classic FICO credit scoring algorithm. First publicized in 2008, this model no longer factored authorized user accounts in the formula for determining one’s credit score. Other features of the new system included less severe penalties for minor delinquencies and harsher consequences for the more drastic delinquencies.

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Home >> Credit Education Center >> Mortgage Eligibility Guide >> Conclusion

Conclusion

The most important things to keep in mind when going into the arena of home mortgages are the relationships that the three eligibility factors have on your loan. Your credit score and loan-to-value ratio can either positively or negatively affect your interest rate, which in turn will affect your monthly payments on the loan for better or for worst. Factoring this into your new debt-to-income ratio, you can get a good idea of whether or not your loan will be a good fit for you at this time.

Remember that, as always, mere eligibility does not necessarily mandate shouldering the responsibility of the loan. It is up to you, the borrower, to determine whether or not it is the right thing for you to do by getting the loan, regardless of if you can qualify for it. The home mortgage is a great boon, but it is also a great liability, so it is vitally important to go into it knowing just what you’re getting into. However, if it is a good fit, your mortgage can be one of the financial greatest windfalls you can find.

In conclusion, please be aware of the value of being an informed borrower. Understanding the factors of eligibility will be an invaluable asset in being able chart your future financial course, and get through what can be a somewhat intimidating process with great ease and peace of mind. Knowledge is power, and information is liberating. Further your knowledge and understanding of these three simple mortgage concepts, and you will soon find that you have in your hands an indispensable tool in securing your financial dreams for the future!

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Home >> Credit Education Center >> Mortgage Eligibility Guide >> Mortgage Insurance

Mortgage Insurance

As alluded to before, another important thing to take note of as it concerns to LTV is the effect which it has on mortgage insurance. If your loan to value is greater than 80%, you will have to pay mortgage insurance, until which time the balance of your loan dips below 80% LTV… but it is notorious for being frustratingly difficult to get rid of even then. Mortgage insurance can often be rather costly, and most borrowers much prefer to find ways to avoid having to pay it.

One of the most popular ways of avoiding mortgage insurance but still having a high loan to value is by taking out a second mortgage. Second mortgages will always have much lower balances, but much higher rates. Because of this, it is often advisable to refinance or otherwise find a way to pay off a second mortgage as soon as you can, to release yourself from the obligation as quickly as possible.

Some of you more savvy readers may at this point wonder, “Hmm… if I can get 80% for a first mortgage, and 20% for the second… why would anyone ever pay a down payment?” The answer to this is simple: the limitation of most lenders in only lending out up to 90% to 95% applies to the combined loan-to-value (CLTV) of the first and second collectively.

Because of this, the most popular way for borrowers to get a home without paying mortgage insurance is called informally the 80/10/10 plan. In this, you take out an 80% first mortgage, “piggy-back” on a 10% second mortgage, and pay 10% down towards your home. Naturally, this can be adapted to an 80/15/5 set up, should one be able to find a lender willing to go up to 95% loan-to-value.

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Home >> Credit Education Center >> Mortgage Eligibility Guide >> Loan To Value

Loan To Value

The final part of the ‘triumvirate’ of eligibility is your loan-to-value (LTV) ratio. In the past, it was often fairly simple to receive 100% financing on a home, meaning you could purchase a home with little to no money out of your own pocket. Nowadays, this cannot be done. Most lenders are restricting borrowers to 90 to 95% maximum loan-to-value.

But what does that mean? For a purchase transaction, the loan to value is determined by the sales price of the house versus the appraised value of the house. For instance, if you need a $120,000 loan to purchase a home that appraises for $150,000, your LTV would be 80%, which is rather favorable, and you would likely be able to get financing for this with minimal scrutiny.

However, if you were attempting to purchase that same home, but rather than the seller asking for $120,000 for the home, he or she was asking for the full $150,000, you would find yourself in a pickle. The LTV for the transaction is now 100%. You would be required to furnish 5% to 10% of the money out of your own pocket in order to purchase the home… and be subject to the dreaded mortgage insurance!

Loan to value ratios become extremely important if you are attempting to refinance an existing property that you own. Since there is no ‘seller’ in this transaction, you cannot use a sales price to determine your LTV ratio. Instead, you need to compare the current value of the home versus the remaining balance on your first mortgage to determine if you can successfully refinance.

Take this scenario for example. You purchased a home five years ago for $150,000. You have paid promptly from day one, heck, you’ve even paid a little extra, and you have decided that you are not happy with your rate. You wish to refinance to lower your monthly payments. You have managed to pay off $25,000 of the mortgage in this time. You contact your mortgage loan consultant, and arrange for an appraisal of your home. The appraisal comes back and you find your home is now with $180,000. Your loan-to-value ratio would be 69%, making for an easy transaction.

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Home >> Credit Education Center >> Mortgage Eligibility Guide >> Debt To Income

Debt To Income

A person may find that their credit score is excellent, but they are not out of the water just yet. The second most important determining factor for mortgage eligibility is your debt-to-income (DTI) ratio. As its name implies, the debt-to-income ratio is a percentage comparing your income to your liabilities. Your level of income is not a factor in determining your mortgage eligibility, so much as your ability to pay your mortgage based on your income versus your obligations. Because of this, a common pitfall a consumer can find themselves in is to believe that due to their high salary they will automatically be viewed favorably by a lender or, conversely, that because of their low salary, they will automatically be rejected.

The primary purpose of the DTI ratio is so that the lender will be able to have some level of assurance that the borrower will be able to meet their monthly obligation. The acceptable level of debt-to-income that a lender will require is very fluid, based on the type of loan you are trying to receive, your available assets, and other such factors. A good rule of thumb is that the ‘limits’ of the DTI ratio are 30/38. What this means is that 30% of your gross income every month should be consumed by your mortgage payment, where 38% of your gross monthly income should go towards your housing obligation plus any recurring debts (credit cards, student loans, etc).

Obviously, these ratios are not set in stone, as you can often qualify with much higher ratios, but it is important to be aware that this is not just a little numbers game. For purchases specifically, if you cannot qualify because your debt-to-income is too high, then that means that the home you are trying to purchase may be too much for you to handle currently… even if you are being assured you could still get the loan if you really wanted to! You must never let yourself to fall into the trap of purchasing a home just because you can qualify for it, without thinking of whether or not you should.

In the end, it is up to your discretion, but with the mortgage market in the state that it is in, it would be prudent to ensure that you do not bite off more than you can chew, for the repercussions in today’s market can be devastating.

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Home >> Credit Education Center >> Mortgage Eligibility Guide >> Red Flags

Red Flags

But what are these regulations? Many borrowers are completely in the dark about what types of things can result in their being denied a loan due to credit reasons. The most common credit “no-no’s” that you will find hindering your getting a loan are as follows:

1- Two or more loan payments 30 days past due in the last 12 months.
2- One or more loan payments 90 days past due in the last 36 months.
3- Bankruptcy in the last seven years.

Any of the three showing up on your credit report will make it difficult if not impossible to receive a loan. Most lenders are extremely unwilling to help borrowers without a proven track record of making their mortgage payments on time, with little discretion concerning extenuating circumstances.

I’ve gone on and on about “credit impacting rate”, but what exactly does this mean, and how does it apply to you, the borrower? For the majority of lending institutions out there, they will charge you as little as an additional .25% to as much as an additional 2% to your rate based on your credit.

With this in mind, it is important to consider the implications of the increased rate. The long and short of it is that your payments will be higher. This sounds rather simple, and you may wonder why I would even state such an obvious thing, but many borrowers don’t realize how this can impact their final chances at their loan. Even if you do qualify for the loan with an inferior rate, this will often negatively affect your debt-to-income ratio, as described in a later section.

It is also important to note that as in all things related to home mortgages, just because you can qualify, you must seriously consider if you should go forward with the transaction. There are many ways in the mortgage world to free yourself from a poor rate, but you have to weigh whether it is worth it to struggle in the present for a chance of greener pastures in the future.

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Home >> Credit Education Center >> Mortgage Eligibility Guide >> Your Credit Score

Your Credit Score

Your credit score is a numerical representation of your credit history (from student loans, credit cards, auto loans, etc) that a lender uses to determine the likelihood of whether or not a borrower (you or I) is a safe investment. When applying for a loan, you will almost always authorize your mortgage loan consultant to pull your credit with personal information you furnish, to immediately get a snapshot of how likely it is that you will be able to move forward towards your home loan.

Despite what many may believe, lower credit scores will not immediately prevent you from being able to get a home loan. It will, however, affect the rate for which you qualify, as described later on.

Credit or FICO scores range from as low as 300 and as high as 850 in the United States. However, for most lenders to provide a borrower competitive rates, the minimum credit score required is usually 630. It is not impossible to receive a loan with lower credit, but most lenders, especially in today’s market, see that point as the lowest they are willing to go, and as such, you will have a much more difficult time.

Credit scores in the 700 and above range will generally warrant little to no additional scrutiny, and will often afford a borrower with the best available rate from most lenders.

With the tightening regulations affecting the mortgage industry these days, better and better credit is being required to receive optimal loans, but never let yourself fall into the trap of believing that your credit score will be all that effects your loan eligibility, for worse or for better.

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Home >> Credit Education Center >> Mortgage Eligibility Guide >> Introduction

Introduction

First things first, it is important to determine just what exactly mortgage ‘eligibility’ is. Many first time homebuyers and veteran homeowners alike are often caught off guard by the requirements for obtaining a mortgage in this market. Contrary to popular belief, eligibility is not determined solely by your credit or FICO score, but is actually contingent upon the combination of three very important factors: your credit score, your debt-to-income ratio, and your loan-to-value ratio.

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Home >> Credit Education Center >> Mortgage Eligibility Guide

Mortgage Eligibility Guide

An insider’s guide to the many factors that determine if you can get a home loan and what it will cost you

Home >> Credit Education Center >> Credit Basics

Credit Basics

These articles are intended to help you to develop a more solid understanding of the fundamentals of credit and borrowing money.

Introduction to Credit - What is credit? Why should you use it? What does it cost?
The Basics of Interest - How does interest work?

Home >> Credit Education Center >> The Basics of Interest >> Making a Payment

Making a Payment

Now let’s say the next month comes along and we make a payment of $50 on the loan. Let’s see what kind of impact this has on our balance:

$3,015 (the balance owed) – $50 (our payment) = $2,965 (the new balance owed)

But we’re not finished yet! The month comes to an end and it’s time to factor in interest once more! Remember, in this case, interest accumulates based on your current balance owed, so let’s figure it out:

$2,965 (the balance owed) x .06 (the APR) = $177.90

Now, remember, we have to divide by 12 to get the monthly interest.

$177.90 / 12 = $14.83

Notice that the amount of monthly interest that accumulates has dropped from $15.00 to $14.83! This is a result of your payment on the loan. Because interest is based on the principal balance, as you continue to make payments in order to reduce the balance, the loan accumulates less and less interest at the end of each month.

Now, let’s go ahead and capitalize that interest:

$2,965 (the balance owed) + $14.83 (the monthly interest) = $2,979.83 (the new balance owed)

As you can see, interest keeps capitalizing into the balance owed; over time, it can really add up.

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Home >> Credit Education Center >> The Basics of Interest >> Conclusion

Conclusion

Now you are hopefully more aware of the effects of interest on paying back your loans. Truly credit is not free; as the cost of borrowing money is found in the interest you pay to the lender over the course of the loan. However, as long as you keep this cost in mind when planning your credit usage, you’ll be ahead of the pack.

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Home >> Credit Education Center >> The Basics of Interest >> Drowning in Debt

Drowning in Debt

In some cases it is possible to “drown in debt”; often this phrase refers to a situation where the interest is capitalizing faster than the borrower can pay it off. Let’s take a look at how this can happen:

Assume that Robert has taken out a $10,000 loan at 9% APR. At the end of his first month, his monthly interest accumulates:

$10,000 (the balance owed) x .09 (the annual interest rate) = $900 (annual interest)

$900 (annual interest) / 12 = $75 (monthly interest)

Capitalize the interest:

$10,000 (balance owed) + $75 (monthly interest) = $10,075.00 (new balance owed)

Next month, Robert makes a payment of $40 on his loan.

$10,075 (balance owed) - $40 (Robert’s payment) = $10,035 (new balance owed)

At the end of month 2, the interest is capitalized:

$10,035 x .09 = 903.15 (annual interest)

903.15 / 12 = $75.26 (monthly interest)

$10,035 (balance owed) + $75.26 (monthly interest) = $10,110.26 (New balance owed)

As you can see, Robert is in somewhat of a dangerous position here; if he continues to only make $40.00 payments each month, the balance owed is going to continue to increase and he will never pay off this loan. The worst part is that it only gets more difficult to pay it back over time because the interest builds on itself and accumulates faster and faster with each passing month. It is for this reason that care should be taken when using credit, as it is quite possible to end up in a situation with no way to pay off your debts.

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Home >> Credit Education Center >> The Basics of Interest >> How Interest is Capitalized

How Interest Is Capitalized

Let’s take a look at some examples to see how interest is capitalized:

Assume you have taken out a $3,000 loan at 6% APR. Let’s further assume that for one reason or another, you don’t make a payment during the first month of the loan. What happens?

Let’s do the math, first let’s figure out the interest:

6% of $3,000 is $180 (annual interest)

Now keep in mind that this is the annual (yearly) interest; since it’s only been one month, we need to divide that interest by 12 to get the monthly interest due. So:

$180 (annual interest) / 12 = $15 (monthly interest)

The amount of interest which accrues at the end of the month is $15.

So since the month has ended, we capitalize the interest by adding it to the original amount owed:

$3,000 (balance owed) + $15 (monthly interest) = $3,015 (new balance owed)

The new balance owed on our loan at the end of the month is $3,015!

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Home >> Credit Education Center >> The Basics of Interest >> Introduction

Introduction

In order to have a full grasp of the cost of borrowing money, it is imperative to have a solid working knowledge of interest and the role it plays in determining how much you end up paying back to the lender. The reason for this is that each month’s interest is capitalized (added) into the total balance due (the amount of money owed to the creditor). There are a few different ways of calculating interest and lenders may use slightly different methods to determine the amount you owe them, depending on a number of circumstances. For now, we’re just going to focus on one of the most common methods.

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The Basics of Interest

Home >> Credit Education Center >> Introduction to Credit >> Conclusion

Conclusion

So now you have a basic understanding of what credit is, why people use it, and what it costs to use. Future articles will go into more detail about each of these subjects, but hopefully you’ve got a more clear understanding of the general subject of credit. Often people make poor decisions with their credit and take out a loan or use a credit card without thinking about how they’re going to pay back that money, plus the interest. As a result, it is common for such individuals to have a lot of debt. On the other hand, the world is also full of people who wisely use their credit to improve their life and achieve long-term financial goals, such as home ownership. Ultimately, credit is a great benefit to those who manage it wisely.

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Home >> Credit Education Center >> Introduction to Credit >> What Does Credit Cost?

What Does Credit Cost?

So far in our look at the basics of credit, we’ve talked about how credit is essentially money that you borrow from someone else with the obligation to pay it back at some future date. The truth of the matter, though, is that in most cases you’re obligated to pay back more money than you originally borrowed in the first place! This is because of something called interest.

Interest is basically the cost of borrowing money. Most of the time interest is expressed in the form of an interest rate; or a percentage of the money you borrowed. Let’s look at a basic example to see how interest works:

When you borrow $500 from somebody, you are expected to pay that $500 back sometime in the future. This $500 is called the principal of the loan or the original balance. Let’s say that you agree to pay back the entire loan, plus 6% interest, in one year. To figure out how much 6% interest is, grab a calculator and do the math: $500 x .06 (or 6%) = $30. So in this case, you’re agreeing to pay back the lender $500 (the principal) + $30 (the interest) for a total of $530.

In the real world, you usually don’t pay back the entire loan at once; it’s more common to pay it back in portions, or installments, over time, usually once a month. For now, however, all that matters is that you have a basic understanding of what interest is and that you understand that you are expected to pay back more money than you originally borrowed.

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Home >> Credit Education Center >> Introduction to Credit >> Why Use Credit?

Why Use Credit?

Much of the time, it is completely possible to go through life without having to touch credit, so why worry about it? The answer is that few of us can truly afford to purchase a new car or home with cash alone. The cost is simply too high and it is rare to find an individual who can drop $200,000 to buy a home. Often we have need for our own transportation or home long before we can save up enough money to buy them in cash. In cases like these, it simply makes sense to take out a loan and pay it back over time.

So we’ve accepted the fact that most of us will need to take out a loan at some point in our lives in order to finance, or pay for, major purchases. So why bother with credit cards or any other kind of credit in the meantime? Good question. The simple answer is that lenders won’t typically lend you an enormous amount of money, such as you might need for a home or car, unless they have some reason to believe that you will, in fact, pay that money back in a timely manner. It turns out that the best way to prove that you’ll pay the lender back is to demonstrate that you have a history of paying back lenders on time; in other words, you have to establish a good reputation. This kind of reputation is called credit history.

Without getting into too much detail, the best way to build up a positive credit history is to take out smaller loans and pay them back over time, whether by taking out an actual loan, or more commonly, by using a credit card and consistently paying back the borrowed money over time. There are companies called credit bureaus that keep track of your payment history on your credit card and any other kind of loan. These credit bureaus are the ones who keep track of your credit history, and when a lender is deciding whether or not to give you a home loan, he essentially contacts the credit bureau and asks to see your credit history. If your credit history indicates that you are a reliable borrower, then you have a much better chance of getting the home loan.

This process is actually a bit more complicated, but what matters right now is that you understand the basics of what’s going on; when someone is deciding whether or not to give you a loan they want to see if you’re the kind of person who will pay the money back!

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Home >> Credit Education Center >> Introduction to Credit >> What Is Credit?

What Is Credit?

There are many different kinds of credit: auto loans, home loans, credit cards, and so forth. Each is different in its own way and has its own rules for how it works, but they all share one thing in common: you are borrowing someone else’s money and are essentially promising to pay it back at some future date (plus interest–which we will cover in more detail later in this reading). Thus, the most basic definition of credit would be: money borrowed from someone else with a legal obligation to pay them back in the future. We call this legal obligation to pay the lender back a “debt”.

For example, let’s look at a car loan: the lender loans you the $10,000 that you need in order to purchase the vehicle; once you receive this money you incur an obligation to pay that $10,000 back to the lender at some future date. In this case, we would say that you have a $10,000 debt.

Consider the following: every time somebody swipes their credit card to pay for goods or services, they aren’t spending their own money, per se. They are actually borrowing someone else’s money in order to pay for the transaction. In doing this, they incur a debt, or an obligation to repay the borrowed money at some future date.

As I said earlier, there are many kinds of credit and we won’t be going into the details of how they differ in this article. For now, just understand that credit is borrowed money that carries a legal obligation to be repaid.

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Home >> Credit Education Center >> Introduction to Credit >> Introduction

Introduction

Have you ever stopped to think about what a house, a car, and a college education have in common? The answer is that most people obtain these three assets the same way: by using credit. From coffee shop cash registers to corporate boardrooms, credit is used nearly everywhere in this day and age.

Often regarded with a mixture of fear and suspicion by those unfamiliar with it, credit plays an increasingly vital role in our lives and in the world around us. What is credit? Why should we use it? What are the costs of using it?

By delving into the fundamentals of credit, we will uncover answers to these questions.

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Home >> Credit Education Center >> Introduction to Credit

Introduction to Credit

Home >> Credipedia >> C >> Callcredit

Callcredit

Definition: A credit bureau located in the United Kingdom

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