Why Your Credit Score is so Important
WHY YOUR CREDIT SCORE IS SO IMPORTANT
Over the last week, I have spoken to a number of potential clients with NO credit score. It’s not a myth – If you pay off all debts, and then stop using your credit lines, your credit history essentially disappears. Usually this happens because you have moved to paying all cash or using a debit card for everything (debit cards pull money directly from your account so they are not considered lines of credit and do not impact your score). Paying as you go is a really great way to budget and can definitely add in an extra feeling of security. The end of the month is a stressful time for everyone, especially when you aren’t sure how many charges you’ve racked up on your credit card.
In theory this sounds like a great idea. Pay as you go, never be late making payments and lose some monthly stress. However, if you go totally “off the grid” credit wise, you can actually be hurting some of your big picture goals – including purchasing a home.
Not having a credit score is not inherently bad. It just greatly increases the hurdles for financing. Lenders rely heavily on your credit score because it shows proof of payment over time. When I look at your credit report, I see your lines of credit and your ability to pay those lines of credit timely. Are you maxing your credit cards out every month? Do you have any accounts in collection? Any derogatory accounts? Your credit report is so important because it shows that you can take out debts and pay them on a monthly basis. Guess what else needs to be paid monthly? That’s right, your mortgage!
Paying for everything in cash is great, but it doesn’t show me that you know how to organize your bills and make sure that they get paid every month on time. And when it comes to a lender giving you upwards of $100,000, they want to be sure this is a skill you have.
So what happens??
You have the option to do something called a manual underwrite on your mortgage in order to get prequalified for a home. Instead of your file running through an automated underwriting system that reads your credit report and loan application, an actual human underwriter needs to review your file and use their best judgement to determine if you can qualify through non-traditional standards. There are other ways to document that you can pay bills on time but it requires lots of organization on your part and collective cooperation with several other parties. The underwriter could ask for proof of timely payment on your rent over the last year or two years. Which requires your landlord to verify you have paid on time every month and that you provide PROOF. Copies of voided checks, receipts, etc. Maybe you have a phone bill you pay directly online that you can provide. There are ways to document payment histories, but none of them are quick. And none of them are easy. At the end of all this, the underwriter may decide there just isn’t enough evidence on your behalf and that you can’t get a mortgage.
Beyond the hassle of documenting non-traditional credit, you are also limiting the number of lenders you can work with. As a wholesale broker, I work with almost 40 different lenders. Need a manual underwrite with no credit? I only have a couple lenders who will look at the file. But what does that mean? Well, you now have far less access to the market. You lose negotiating power when it comes to your interest rate. If you only have 1 lender who is willing to take your mortgage, you get the rate the offer and that’s that. You can also come up against lender overlays, guidelines that are upheld in ADDITION to the guidelines of the federal government. So more documents to provide and more room for a lender to say no to you.
My recommendation to all the people I have talked to is to take out one credit card and use it for the essentials. Whether it’s strictly used for gas or groceries – pick costs they are generally pretty fixed on a monthly basis, and things you are paying for no matter what. Then you know you can pay off your card every month. Building up your credit score will open so many more doors for you on the mortgage side.
Waiting for a few months to have a decent score is worth it when you are looking at taking on the
longest line of credit of your life – a 30 year mortgage.