Improve Credit Scores

BEYOND CREDIT SCORES: LOAN APPROVAL

When it comes to loan approval, lenders will use different criteria for different situations. Unsecured debt is riskier than secured debt in general since there's no collateral involved in unsecured debt. You see, it's all about "what happens if you default?" A house or auto is collateral, and if you default, the lender can always come and take that collateral to mitigate its loss. If you're getting a good deal on a car and putting money down, you have a better chance of getting approved than if you're paying above book value and putting no money down. Once again, if the lender repossesses the car due to nonpayment, then it can mitigate its loss if there's equity in the car. Likewise, if you already own property and have equity, then you are a better credit risk than if you don't.

If you have an established relationship with the lender (i.e., it has extended credit to you previously, or you have a checking/savings account with it), it helps. It also helps if you deal face-to-face with a loan officer at your bank, because you become more than just a name. Some banks can still approve loans at branch level, so ask the branch manager about this before you fill out an application. However, most underwriting is no longer preformed by a branch, but at a corporate office-where you're just another name on a piece of paper. In such cases your credit score and your debt-to-income ratio will determine your creditworthiness, period.

This is not necessarily a bad thing. Such an approach helps to ensure that people are treated equally, as do restrictions imposed by the federal government, which provide a minimum standard for loan underwriting. This not only helps to keep a certain level of fairness in play but also provides a way to keep overzealous loan officers from making bad decisions, i.e., loaning to people who are high risk. This keeps the entire financial and banking system strong and also ensures that the secondary markets are not faced with a financial crisis due to an increase in loans that go unpaid by homebuyers.

The secondary market is in place to ensure that there's plenty of money available for banks to make home loans. Let's say the consumer mortgage division of a bank has $100 million to loan. If they loan it all out, how can they continue to make loans? This is where the secondary market comes in. Once a bank loans you money, it will likely want to sell that note to the "secondary market," so that it can get additional capital to loan again. The largest secondary market purchasers of these mortgage loans are the Federal Home Loan Mortgage Corporation ("Freddie Mac") and the Federal National Mortgage Association ("Fannie Mae"), which are publicly traded private companies, congressionally chartered entities that are known as "government-sponsored" enterprises. They buy home loans from banks and other lenders and then wrap them into mort-gage-backed, publicly traded securities (stocks), which are sold to investors. The federal government has guidelines about what loans can qualify to be sold on the secondary market, such as the 45 percent debt-to-income ratio, which is why banks' hands are often tied when it comes to loan approval.

Freddie Mac and Fannie Mae are the only secondary market enterprises, since they're the only ones Congress chartered to serve the secondary market, keeping money available for banks to make home loans. It's a circle, put in place so that the lending system continues to work.

Some banks offer another type of mortgage, the portfolio loan. If you have bad credit but have 20 to 25 percent to put down, you can buy property under this method, providing you place the property into a separate business entity, such as a corporation or limited liability company (LLC). This option won't hurt your credit score as a sub-prime loan will, and such a loan will be reported on a business credit report, not your personal credit report (unless the loan becomes delinquent, in which case it may be reported on the personal report of anyone who is a guarantor of the note).

Also be aware that those who get their middle score to 700-plus can often use "stated income" to get the mortgage they desire. Such an approach is attractive, since the use of stated income permits the borrower to forgo revealing previous tax returns.

Alternative sources of home mortgage loans are available to those with poor credit, but the interest rates are often several points higher and the terms undesirable. As explained, having these subprime lenders on your credit report will hurt your score as well, since FICO classifies them as undesirable. I don't recommend these types of loans, especially considering that if you wait and repair your credit, you can obtain conventional funding anyway. One exception would be a sub-prime loan used as leverage in any Debt Fusion^TM plan (see Chapter 8).

Getting Loans Approved under Adverse Conditions

Of course, the best thing you can do for a score is to take the time to remove the bad credit and pay your bills on time. But if you can't wait for that or you lack sufficient credit history, you still may be able to obtain an auto loan or credit card using quality lenders.

I used to recommend Ford Motor Credit for auto loans, but it has since toughened up its policies. I also used to recommend Capital One secured credit cards, but since it doesn't report high limits and is screwing 48 million customers, I cannot in good conscience recommend the firm. I used to recommend American Pacific Bank's secured credit cards, but it has since been bought out by Riverside Bank and no longer offers that card.

Since things change so rapidly, I think it's best to just send you to my Web site, www.bestcredit.com/badcreditlenders/. There you will find the best bad credit offers available. And, of course, if you have any knowledge of such lenders, let me know and I'll post it.

In closing, by understanding the various components of FICO scoring and lender criteria for loan approval, you can begin formulating a coherent strategy for raising your score. Of course, this doesn't begin to address the removal of bad credit. Far more complex, credit restoration requires a great deal more knowledge, the foundation of which is an understanding of some fundamental ground rules.