A high credit score is often seen as the magic number to close a deal. Sometimes it is. Sometimes it’s not.
While many lenders use auto-decision models built on minimum credit scores, it’s not as cut and dry for clients with poor credit history or bankruptcy issues. Identity confusion, reporting errors and reporting omissions can have ‘make it or break it’ impact if they are not corrected. Then there are ‘forced’ Beacon scores which don’t truly reflect a client’s likelihood of obtaining a mortgage. Even a client with a good credit history can score a surprisingly low score — at least at first glance.
Defining the Credit Score
“I don’t think a day goes by when I don’t receive one or more calls from mortgage brokers asking for an explanation of a specific credit score,” says Domenic Altomare, Equifax. “Since lenders are placing more and more emphasis on credit scores in the adjudication and rate setting process, greater knowledge of credit scoring would serve all parties.”
There are three credit bureaus in Canada: Equifax, Trans Union and Northern Credit Bureau, with Equifax and Trans Union dominating 99 per cent of the market. Experts believe that over 95 per cent of data from all major players is reported to both Equifax and Trans Union. Traditionally, credit unions did not report to either bureau but that’s changing. However, the consumer who deals exclusively with a non-reporting credit grantor should be aware that this means they will not have a credit rating — good or bad.
Financial institutions may have custom application scorecards for different portfolios. One score may be used for lines of credit, another for loans and yet another for mortgages. The scoring models used in the mortgage industry are referred to as ‘bureau scores,’ most commonly Beacon scores, the model used by Equifax. Trans Union’s scoring model, Empirica, is built substantially the same as the Beacon score and both scores range from 300-900.
“Theoretically, if Equifax and Trans Union delivered the credit bureau report, it should be the exact same data on both reports,” says Mark Merritt, director of Trans Union Canada. “We present ours a little bit differently but if the exact same data is reported, the scores will be the same.”
Merrit says Trans Union has been less utilized in the mortgage industry simply because the company has traditionally gone after different markets. “The mortgage industry has not been a big initiative for Trans Union in the past,” he says. “However as we grow and expand, it is now becoming a much bigger market potential for us, as are the credit unions.”
Merritt was a participant in building the Beacon and Empirica scores for Fair Isaac. He says the first misconception about credit scores lies in their very purpose.
“The credit score doesn’t measure the credit worthiness of somebody today,” explains Merritt.“A credit score is built to predict 12-24 months into the future. If you want a snapshot of today, look at the credit bureau report.”
Merritt uses the example of a client who is current and doesn’t have any delinquencies on his credit report yet only scores 580. “This client has ten fully utilized credit cards, he’s seeking new credit and the types of products that he’s seeking are high risk,” explains Merritt. “The whole concept of scoring is that past performance will predict future behaviour.”
One of the most common concerns amongst brokers is the issue of multiple inquiries. Consumers are encouraged to shop around but every time they seek credit, it’s another hit on their credit score. Or is it?
“Statistically, it has been proven that there is a higher credit risk if someone is looking for new credit accounts within a short period if their existing cards are at their credit limits,” says Altomare. “However, most credit scoring models treat mortgage and auto inquiries in a special manner. Multiple inquiries, regardless of the number, for mortgages and autos, in a 14 day period only count as a single inquiry in the impact on the credit score.”
For those brokers who are still skeptical, there may be overlooked factors on the report that are causing the score to drop other than multiple hits. A credit score can vary from one day to the next, simply because of timing in the reporting.
“The most important thing for brokers to know is how a Beacon score works,” says Jane Kulbida, Co-operative Trust of Canada. “A high balance on the credit limit is more important than the number of enquiries. If they have lots of credit cards or loans with high limits, we know that two years from now these people are going to be in trouble. Credit is easy to get. As a lender, I’m looking at the number of months reporting and whether the client has actually used the credit and paid it back.”
One late payment can plummet a 680 Beacon score down to 610. If the client then drives the credit card’s available credit past 80 per cent, it can cost them preferential mortgage rates or even the mortgage. The types of credit products that an individual has historically used will also affect his credit score. A client who is typically delinquent with five fully utilized credit cards and is going to a finance company for debt consolidation is a higher risk.
“The Beacon is an indicator,” says Audrey Wamboldt, INVIS. “It’s reflective of the entire picture but Beacons can be influenced by so many factors that you really have to review the individual trade lines. If you’re within 80 per cent of your available balance for credit, and you’re going for high ratio refinancing, CMHC and GE will consider that default management. If you’re constantly refinancing things to improve your picture, instead of paying things off, it also affects you. You’re just shuffling the debt.”
A young person starting out with one credit card and no reporting history will typically have a very high score, known in the trade as a ‘forced Beacon.’ This is a classic case where the score won’t dictate the deal. There simply isn’t enough credit history to take the score at face value.
Deferred student loans are not used in a calculation of a score but there are often reporting discrepancies when a student is on interest relief.
“In many cases, we see that the student waits until the last minute before making a request for interest relief,” Altomare says. “As such, the financial institution may begin reporting that the account has been aging (i.e. I1, I2, I3). If a student loan is currently on interest relief, the trade item should report on the bureau as I0. “I” indicates that it is an installment loan and “O” indicates the account is too new to rate (i.e. approved but not yet used). Equifax relies on the credit grantors to correctly report and update information on their accounts.”
Traditionally, mortgages have not been reported but Altomare says this is likely to change. Equifax has already completed all of the necessary IT testing and preparation to receive and disseminate the mortgage data. “Equifax has been part of an industry initiative to have the major financial institutions begin reporting mortgage information,” Altomare says. It has not been determined when the mortgage data will become part of the credit scoring model. “Generally, the development of a scoring model requires two years of historical data.”
Double Dipping
Some lenders and insurers will pull both bureaus to ensure they are getting the whole picture. “CMHC has developed a proprietary method to ensure that the risk assessment of both credit bureau agencies is consistent for mortgage insurance purposes,” says Dean Durnford, CMHC. “The insurer would pull both bureaus if one of the bureaus was down or if one bureau isn’t reflecting the picture an originator expected to see. Those differences may be simply a matter of timing in reporting but they could also reveal incorrect reporting or other errors. The key is to use these tools to get the best and most accurate representation of the consumer’s credit profile so we can assess risk.”
Durnford says a significant portion of CMHC homeownership applications are automatically approved by CMHC’s automated mortgage loan insurance risk management system which assesses an applicants overall probability of success, evaluating the applicant, assessing the market and the property. Applications which are not automatically approved are referred to a local CMHC underwriter who works closely with clients to manage any identified risks. If lenders or brokers have concerns about differences between the bureaus, the CMHC underwriter could work with them to discover the cause.
“Where consumers have erroneous or incorrect information reported on their credit files, those involved in mortgage initiation can provide value added information to counsel their clients on processes for correcting the situation,” says Durnford. “The lender would verify and document it on its file as part of its normal due diligence. The lender would then send this information along to CMHC.”
Reporting Errors
Experts advise that a consumer check his credit status annually, at both bureaus. If the client is considering a major purchase, a supplementary check three months prior is advised to allow time to deal with any unresolved issues that might appear on the report.
Consumers can request that a correction be made to their file either by phone, in-person or on-line. Personal information can be corrected by providing official supporting documentation. Credit information can be corrected after the credit bureau conducts an investigation with the credit grantor who reported the information. They also have the option to add their own narrative explaining any errors or extenuating circumstances that may be negatively affecting their report.
“Because of fraud and forgery issues, it’s very important to provide the same personal information every time a consumer seeks credit,” says Wamboldt. “Especially in cases where it’s a common name or there’s a ‘junior’ and ‘senior.’ It can cause a lot of work because the broker has to go back to the customer who may then dispute, ‘That’s not me, that’s my dad.’”
Wamboldt has also seen situations where a consumer has an overdraft or a note loan from a bank that isn’t paid. The account is closed but the overdraft is left in place.
“This will be reported as an R9, which means eventually there could be a collection or a judgment,” says Wamboldt. “That’s when I would advise my customer that he needs to pay it. You get customers who say they paid it but don’t have a receipt. They need to pay it again. Consumers don’t like hearing that but paying $500 to enable you to get a $100,000 mortgage is well worth it.”
“If a trade is under dispute, we will take that specific piece of trade off and put a dispute flag on it,” says Merritt. “That means it will not be used in the calculation of the score. We can’t say you’re right. We also can’t say you’re wrong. We want to make sure the information is correct. So we just take it out until that dispute is resolved.” In the case of repairs or updates, once verification is received, the information will appear on the consumer’s file but it generally takes 30 days to appear on a consumer’s credit report.
“Most consumer grantors offer 30 day terms and this is the rationale behind the 30 day reporting cycles,” says Altomare. “The most common situation where an update can be fast tracked is where the credit grantor may have reported erroneous information on a consumer. In a case such as this, a manual update would be applied to the credit report to make a correction.”
Equifax’s Consumer Relations department fields approximately one hundred and fifty thousand consumer change requests annually so in order to serve consumers effectively, the bureau separates the urgent requests from the non-urgent. An urgent request would be where a consumer has been refused a loan.
Bankruptcy
Those with poor credit or bankruptcy issues rely much more heavily on the broker’s ability to package the deal. Eric Gall, Home Loans Canada, bills himself as a ‘lending solutions specialist’ working exclusively in the sub-prime market. Credit scores rarely figure in his deals, unless the client is self-employed or seeking a ‘no money down’ product.
“The majority of my clients have credit issues,” Gall explains. “It’s my job to pick the credit report apart and find the story of what happened and why.”
Galls says he underwrites nearly every deal before he sends it to a lender. “I know the policies of each of my lenders and who will be able to buy that deal. Most of the time, my clients have had problems over a certain period and there’s usually a legitimate reason. It’s my job to explain the credit report. I also explain to the client how to get back into traditional banking. I’ve seen situations where clients didn’t want to go bankrupt because they wanted to pay the debt back. The funny thing is, if they would have gone bankrupt, I could have done the deal for them.”
The Superintendent of Bankruptcy reports to the credit bureau but it’s also necessary for the lender to update its portfolio. When the lender receives the bankruptcy documents it will also report to the credit bureau all the debts which are included in the bankruptcy. If that information doesn’t appear on the client’s report, or some items are not included, the consumer can submit the letter to the credit bureau from the Superintendent of Bankruptcy to correct the omissions. Once a bankruptcy is discharged, lenders and insurers will be watching closely. Most important for ex-bankrupts is to reestablished trade lines after the bankruptcy with 24 months reporting.
“If a borrower’s credit history includes a bankruptcy and there are inconsistencies, as a guideline it is expected that the bankruptcy should be discharged for at least two years,” says Durnford. “During that time period, the consumer should have re-established credit with sound money management patterns, good savings and credit repayment.”
“Brokers ask ‘how does the lender view bankruptcy and the reestablishment of credit?’” says Kulbida. “’Do you look at the number of months reporting or do you look at when it was open?’ My answer is, ‘You look at both.’”
Kulbida notes that because certain products rely exclusively on Beacon scores, those with credit issues may have better luck with a smaller lender. “Definitely if they have credit issues,” she says. “How many times do you get, ‘my son was in a car accident’ or ‘the kids were sick and we had to travel to the Mayo Clinic.’ Those kinds of people probably get lost in the bigger lenders that use auto decision models.”
Kulbida takes some credit report issues with a grain of salt. “Lots of people don’t understand when their payments are supposed to begin. Everybody has R2s on Sears cards because Sears is very quick to report late payments,” she says. “You don’t discount that information, but you keep it in the back of your mind.”
Rebuilding Credit
Rebuilding credit — whether it’s after a bankruptcy or a run of misfortune — is essentially the same. Car leases, RSP loans and secured credit cards are options open to virtually everybody. Take it slow, take it small and take it easy. A strong relationship between the broker and lender also goes a long way.
“If a broker has never sent us a deal that went delinquent that definitely plays a part,” Kulbida says. “If that broker says, ‘I’m vouching for this guy,’ — you’ll trust that.”
Most of the public are in the dark when it comes to credit scores and reports. Brokers play a key role in helping a client understand how credit works and how to keep or re-establish strong credit.
“More important than anything else that brokers do, we educate the consumer on credit,” says Wamboldt. It’s important for the consumers to have that information passed on to them and you can only do it one person at a time.”
Nancy Jakubic is a freelance writer based in Winnipeg.
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