Knowledge Center

What is a Credit Score?

Ever wonder why you can go online and be approved for credit within 60 seconds? Or get pre-qualified for a car without anyone even asking you how much money you make? Or why you get one interest rate on loans, while your neighbor gets another? The answer is credit scoring. Credit scores are used extensively, and if you’ve gotten a mortgage, a car loan, a credit card or auto insurance, the rate you received was directly related to your credit score. The higher the number, the better you look to lenders.

Your credit score is a number generated by a mathematical algorithm — a formula — based on information in your credit report, as that information is compared to other credit profiles with similar matching characteristics as your credit file. The resulting number is a highly accurate prediction of how likely you are to pay your bills on time, or conversely, go delinquent on a debt.

Credit scores are used extensively, and if you’ve gotten a mortgage, a car loan, a credit card or auto insurance, the rate you received was directly related to your credit score. The higher the number, the better you look to lenders.

Scoring categories

Lenders can use one of many different credit-scoring models to determine if you are creditworthy. Different models can produce different score ranges. However, lenders use some scoring models more than others. The FICO score is one such popular scoring method.

The FICO scoring models range from 300 to 850. The vast majority of people will have scores between 600 and 800. A score of 720 or higher tends to get competitive interest rates on a mortgage, according to data from Fair Isaac Corp., a California-based company that developed the first credit score as well as the FICO score.

Currently, each of the three major credit bureaus uses their own version of the FICO scoring model — Equifax uses the BEACON model, Experian uses the Experian/Fair Isaac Risk Model and TransUnion uses the EMPIRICA model. The three models can come up with varying scores because they use different algorithms. (Variance can also occur because of differences in data contained in the source data from each credit bureau.)

That could change, depending on whether a new credit-scoring model catches on. It’s called the VantageScore. Equifax, Experian and TransUnion collaborated on its development and will all use the same algorithm to compute the score. Its scoring range runs from 501 to 990 with a corresponding letter grade from A to F. So, a score of 501 to 600 would receive an F, while a score of 901 to 990 would receive an A. Just like in school, A is the highest grade you can get.

What’s the Big Deal?

No matter which scoring model lenders use, it pays to have a great credit score. Your credit score affects whether you get credit or not, and how high your interest rate will be. Whether you are dealing with a mortgage banker, mortgage broker, or any mortgage company, a better score will result in a competitive interest rate.

The difference in the interest rates offered to a person with a score of 520 and a person with a 720 score is 4.36 percentage points, according to Fair Isaac’s Web site. On a $100,000, 30-year mortgage, that difference would cost more than $110,325 extra in interest charges, according to Bankrate.com’s mortgage calculator. The difference in the monthly payment alone would be about $307.

Powerful Little Number

If you rented an apartment, got braces, bought cell phone service, applied for a job that involved handling a lot of money, or needed to get utilities connected, there’s a good chance your score was pulled. If you have an existing credit card, the issuer is likely to look at your credit score to decide whether to increase your credit line — or charge you a higher interest rate, according to a credit scoring study by the Consumer Federation of America and the National Credit Reporting Association.

*Note: American Pacific Mortgage Corporation is not a credit repair company; this information is for information purposes only. We are not licensed credit repair specialists or counselors.*

The interest rate you’ll pay for the money you borrow will be determined, in large part, by this three-digit number that’s generated from the information in your credit report. Most lenders have carved-in-stone rules about handing out terms, and those rules almost always place a major emphasis on your credit score. If their most competitive rates are offered to borrowers with a score of 700 or higher and yours is a 698, those two points could cost you thousands of dollars.

If you’re thinking about buying a house or a car, your credit score is a very important number.

The interest rate you’ll pay for the money you borrow will be determined, in large part, by this three-digit number that’s generated from the information in your credit report.

According to www.myfico.com, the consumer Web site of the Fair Isaac Corp. that created the FICO score (the most commonly used credit score), the interest rate difference between those two scores is about one-third of a percentage point.

Keep in mind that these are averages. Most lenders today practice tiered pricing, with interest rates rising as scores go down. Each lender chooses its own “break points” between tiers. One mortgage lender may bump up the interest rate if a score falls below 700, while another mortgage banker doesn’t charge higher rates until the score is 690 or below. So working with a lender that can help you develop behaviors that can raise your score and keep you in the sweet spot for the most competitive possible rate is vital.

This underscores the importance of not only doing all you can to improve your score, but shopping thoroughly for the right loan officer when looking for a great mortgage.

You can take steps to improve your credit score. The numbers of variables that play into an individual score make it impossible to say that one particular action will increase a given score by a certain number of points. But there are some good guidelines. According to Craig Watts, consumer affairs manager at Fair Isaac, “The mantra for getting a great score is pay your bills on time, keep account balances low, and take out new credit only when you need it. People who do that faithfully have very high scores. It usually means you’re being conservative and cautious about credit. Credit is not a toy and it shouldn’t be a hobby.”

*Note: American Pacific Mortgage Corporation is not a credit repair company; this information is for information purposes only. We are not licensed credit repair specialists or counselors.

Discount points are fees paid to a lender at closing in order to lower your mortgage interest rate. While buying points is sometimes a good decision, many times the purchase costs you more than it saves. The cost of each point is equal to one percent of the loan amount. For instance, for a $100,000 loan one discount point equals $1,000. Each discount point paid on a 30-year loan typically lowers the interest rate by 0.125 percent. That means a 7.5 percent rate would be lowered to 7.375 percent if you purchase one point. Paying for points lowers your interest rate, because the lender receives the income in a lump sum at closing rather than collecting the interest as you make payments on your loan.

Buying Points to Lower Your Interest Rate, It’s Not Always a Good Idea

Discount points are fees paid to a lender at closing in order to lower your mortgage interest rate. While buying points is sometimes a good decision, many times the purchase costs you more than it saves.

How Much Do Points Cost?

The cost of each point is equal to one percent of the loan amount. For instance, for a $100,000 loan one discount point equals $1,000.

How Much Does Buying a Point Lower Interest?

Each discount point paid on a 30-year loan typically lowers the interest rate by 0.250 percent. That means a 5.5 percent rate would be lowered to 5.250 percent if you purchase one point. This varies from day to day and dependent on the specific loan program.

Paying for points lowers your interest rate, because the lender receives the income in a lump sum at closing rather than collecting the interest as you make payments on your loan.

Should I Buy Points?

Whether or not paying points makes sense for you depends in part on how long you plan to keep the loan. Use a mortgage calculator to help you decide.

Calculate the amount of your monthly payment at the interest rate you will be charged if you do not pay points.

Calculate the amount of your monthly payment at the lower rate if you do pay points.

Deduct the lower payment from the higher payment to find the amount saved each month.

Divide the amount charged for points at closing by the monthly amount saved. The result is the number of months you must keep the loan to break-even on paying points.

Break Even Example – $100,000 Loan – 30 Year Term

5.5% Interest, no points = $567.79 monthly payment

Buying 1 point for $1,000 = monthly payment $552.20

Monthly Savings = $15.58

$1000 / $15.58, = 64 months

Your break-even point is 64 months-or over 5 years to recover the cost of buying the discount point (considering only the simple calculation of those funds at today’s value).

Do you plan to stay in the house that long? If not, buying points might not make sense.

Slightly Lower Principal Balance

If you were to look at amortization schedules to compare the two loans, you’ll see that the lower interest loan does have a slightly lower principal balance at the end of 64 months. This is one additional reason to pay points to get the lowest rate possible, but only if you plan to live in the home long enough to reap the rewards.

Can the seller pay for my discount points?

Probably. Talk with your lender about what’s allowed with your loan. A motivated seller will sometimes agree to pay some of your closing costs in order to facilitate a quick transaction. A mortgage lender who works closely with your real estate agent is a way to facilitate this discussion in your favor.

Are discount points tax deductible?

Yes, points paid for the purchase of residential real estate are tax deductible in the year they are paid. Buyers may deduct the amount paid even if the seller pays for the points at closing.

Are discount points the same as an origination fee?

An origination fee is a fee charged to originate and process your loan. It typically costs the same as one point, but it is a different type of fee. Ask each loan officer or mortgage broker you talk with if you will be charged an origination fee in addition to discount points. Many loan officers will use a term like, “this loan will cost you 2 points” when in fact, there may be a 1% loan origination fee and a 1% loan discount points fee.

A lock-in, also called a rate-lock or rate commitment, is a lender’s promise to hold a certain interest rate and a certain number of points for you, usually for a specified period of time, while your loan application is processed. Depending upon the lender, you may be able to lock in the interest rate and number of points that you will be charged when you file your application, during processing of the loan, when the loan is approved, or later.

Rate Lock Period

In most cases, the terms you are quoted when you shop among lenders only represent the terms available to borrowers for a very short period of time who are settling their loan agreement at the time of the quote. The quoted terms may not be the terms available to you at settlement weeks or even months later.

What Is a Lock-In?

A lock-in, also called a rate-lock or rate commitment, is a lender’s promise to hold a certain interest rate and a certain number of points for you for a specified period of time, while your loan application is processed. (Points are additional charges imposed by the lender that are usually prepaid by the consumer at settlement but can sometimes be financed by adding them to the mortgage amount. One point equals one percent of the loan amount.) Depending upon the lender, you may be able to lock in the interest rate and number of points that you will be charged when you file your application, during processing of the loan, when the loan is approved, or later.

A lock-in that is provided when you apply for a loan may be useful because it’s likely to take your lender several weeks or longer to prepare, document, and evaluate your loan application.It is important to recognize that a lock-in is not the same as a loan commitment, although some loan commitments may contain a lock-in. A loan commitment is the lender’s promise to make you a loan in a specific amount at some future time. Generally, you will receive the lender’s commitment only after your loan application has been approved. This commitment usually will state the loan terms that have been approved (including loan amount), how long the commitment is valid, and the lender’s conditions for making the loan such as receipt of a satisfactory title insurance policy protecting the lender.

Will Your Lock-In Be In Writing?

All lenders have government regulated Loan Estimate form (LE’s) that set out the exact terms of the lock-in rate agreement. This form must be provided to you in writing within three days of locking your loan interest rate and other origination charges.

If a lender is offering you a verbal lock-in agreement, seek different advice from a professional loan officer with a proven track record who can protect your interest and ensure you are treated fairly.

Will You Be Charged for a Lock-In?

Lenders may charge you a fee for locking in the rate of interest and number of points for your mortgage. Some lenders may charge you a fee up-front, and may not refund it if you withdraw your application, if your credit is denied, or if you do not close the loan. Others might charge the fee at settlement. The fee might be a flat fee, a percentage of the mortgage amount, or a fraction of a percentage point added to the rate you lock in. The amount of the fee and how it is charged will vary among lenders and may depend on the length of the lock-in period. Ask question up front to ensure you understand the terms of your rate lock.

How Long Are Lock-Ins Valid?

Usually the lender will promise to hold a certain interest rate and number of points for a given number of days, and to get these terms you must close on the loan within that time period. Lock-in periods of 30 to 60 days are common. But some lenders may offer a lock-in for only a short period of time (for example, 7 days after your loan is approved, while sending your loan documents to title) while others offer longer lock-ins (up to 120 days) for new construction purposes. Lenders typically charge a higher fee for the longer lock-in period. Usually, the longer the period, the greater the charge or fee.

The lock-in period should be long enough to allow for settlement, and any other contingencies imposed by the lender, before the lock-in expires. Before deciding on the length of the lock-in to ask for, you should find out the average time for processing loans in your area and ask your lender to estimate (in writing, if possible) the time needed to process your loan. You’ll also want to take into account any factors that might delay your settlement. These may include delays that you can anticipate in providing materials about your financial condition and, in case you are purchasing a new house, unanticipated construction delays. Add some contingency time, just in case unexpected delays occur.

What Happens If the Lock-in Period Expires?

If you don’t close your loan within the lock-in period, you might lose the interest rate and points you had locked in. This could happen if there are delays in processing or closing whether they are caused by you, others involved in the settlement process, or the lender. For example, your loan approval could be delayed if the lender has to wait for any documents from you or from others such as employers, appraisers, termite inspectors, builders, and individuals selling the home. On occasion, lenders are themselves the cause of processing delays, particularly when loan demand is heavy. This sometimes happens when interest rates fall suddenly.

If your lock-in expires, most lenders will offer the loan based on the newer prevailing interest rate and points. If market conditions have caused interest rates to rise, most lenders will charge you more for your loan. One reason why some lenders may be unable to offer the lock-in rate after the period expires is that they can no longer sell the loan to investors at the lock-in rate. (When lenders lock in loan terms for borrowers, they often have an agreement with investors to buy these loans based on the lock-in terms. That agreement may expire around the same time that the lock-in expires and the lender may be unable to afford to offer the same terms if market rates have increased.) Lenders who intend to keep the loans they make may have more flexibility in those cases where settlement is not reached before the lock-in expires.

Some mortgage companies will permit you to extend the loan for a few days, but that offer is entirely up to the secondary market condition at the time. Working with a strong, nimble, and reputable lender is the recommended course of action.

How Can You Speed Up the Approval of the Loan?

While the lender has the greatest role in how fast your loan application is processed, there are certain things you can do to speed up its approval. Try to find out what documentation the lender will require from you.

Much of the information required by your lender can be brought with you when you apply for a loan. This may help to get your application moving more quickly through the process. When you first meet with your lender, be sure to bring the following documents:

The purchase contract for the house (if you don’t have the contract, check with your real estate agent or the seller).

Your bank account numbers, the address of your bank branch and your latest bank statement, plus pay stubs, W-2 forms, or other proof of employment and salary, to help the lender check your finances.

If you are self-employed, balance sheets, tax returns for 2-3 previous years, and other information about your business.

Information about debts, including loan and credit card account numbers and the names and addresses of your creditors.

Evidence of your mortgage or rental payments, such as cancelled checks.

Certificate of Eligibility from the Veterans Administration if you want a VA-guaranteed loan. Your lender may be able to help you obtain this.

Be sure to respond promptly to your lender’s requests for information while your loan is being processed. It is also a good idea to call the lender and real estate agent from time to time. By calling occasionally, you can check on the status of your application, and offer to help contact others such as employers who may need to provide documents and other information for your loan. It is also helpful to keep notes on your contacts with the lender so that you will have a record of your conversations.

Loans can be confusing. Slick lenders can quote a lot of different numbers that mean different things. In an order to reduce confusion, the US Government passed the Truth in Lending Act. One of the provisions of this act is that lenders quote APR to potential borrowers. APR allows you to evaluate the cost of the loan in terms of a percentage. If your loan has a 10% rate, you’ll pay $10 per $100 you borrow annually. All other things being equal, you simply want the loan with a competitive APR.

Annual Percentage Rate (APR) is a way to compare the costs of a loan. Although it’s not perfect, it gives you a nice standard for comparing the percentage costs on different loans. This page covers the basics of APR, and how you can calculate it.

Why Use APR?

Interest rates, and the fees required to obtain a given rate from a given lender can be confusing especially when comparing one lender to another.

What is APR?

The APR allows borrowers to evaluate the costs of a loan in a government standard. This standard requires a calculation using a combination of both the interest rate and fees associated with a given loan, and, through a computer program whose formulas are set by the regulators, takes all of the costs of the costs of the loan an “adds” them to the stated interest rate, thereby creating a unique APR for each rate quote.

APR Limitations

Unfortunately, some lenders, in an effort to avoid penalties from regulators, over disclose the fees that are included in the APR calculation, and include other fees that are not required to be included in the APR. As a result, what was meant to equally compare one mortgage company’s rates and fees on an equal basis to another’s this practice of over disclosure can sometimes negate the whole purpose of the Loan Estimate and APR calculation. You’ve heard the saying, Garbage in; Garbage out. Therefore, look closely at each APR to see differences in the fee structure that could contribute to confusion. Remember, North Pacific Mortgage loan originators can help you analyze these documents .

You can’t simply rely on an APR quote to evaluate a loan. You need to look at each and every charge and expense related to your prospective loan in order to judge whether or not you’re getting a good deal. In addition, look at the bigger picture – you need to know how long you’ll be using a loan to make the most informed decision. For example, one-time charges up front may drive up your actual cost on a loan – even though an APR calculation might assume those charges are spread out over a longer lifetime (and therefore the APR would be lower).

APR Example

APR seems really easy, but it’s amazing to watch the numbers (and your costs!) change with different scenarios.

Assume you will borrow $100,000, and the lender tells you you’ve got a 7% interest rate. You also have $1,000 in closing costs. The APR on a 30 year fixed-rate mortgage would be 7.10%.

To test this, try the math yourself. In Microsoft Excel, follow these steps:

Find the monthly payment for loan and closing costs:

=PMT(0.07/12,360,100000)

The format is: PMT(rate,nper,pv,fv,type)

.07 divided by 12 is the rate (you’re using a monthly rate to find monthly payments)

360 is the number of periods (payments or months – 30 years here)

100,000 is the present value of your loan (including additional costs)

You should have a result of $665.30.

Next, Solve for the APR:

=RATE(360,-665.30,99000)

The format is: RATE(nper,pmt,pv,fv,type,guess)

360 is the number of periods you pay on the loan (360 months or 30 years)

- 671.96 is your payment

99,000 is the present value of your loan (how much you’re actually borrowing)

You should have a result of .592%. This is a monthly rate. Multiply by 12 to get 7.0999%.

Which is the better mortgage option for you: fixed or adjustable? The low initial cost of adjustable-rate mortgages (ARMs) can be very tempting to home buyers, yet they carry a great deal of uncertainty. Fixed-rate mortgages (FRM) offer rate and payment security, but they can be more expensive. Here are some pros and cons of ARMs and FRMs.

Which is the better mortgage option for you: fixed or adjustable?

The low initial cost of ARMs can be very tempting to home buyers, yet they carry a great deal of uncertainty. Fixed-rate mortgages offer rate and payment security, but they can be more expensive.

Here are some pros and cons of each type of loan.

ARM advantages

Feature lower rates and payments early on in the loan term. Because lenders can use the lower payment when qualifying borrowers, borrowers can purchase larger homes than they otherwise could buy.

Allow borrowers to take advantage of falling rates without refinancing. Instead of having to pay a whole new set of closing costs and fees, ARM borrowers just sit back and watch their rates fall.

Help borrowers save and invest more money. Someone who has a payment that’s $100 less with an ARM than with a Fixed Rate Mortgage for a couple of years can save that money and earn more off it in a higher-yielding investment.

Offer an inexpensive way for borrowers who don’t plan on living in one place for very long to buy a house.

ARM disadvantages

Rates and payments can rise significantly over the life of the loan. A 3 percent* Conventional ARM can end up at 9 percent in just three years if rates rise quickly and steadily.

A borrower’s initial low rate will adjust to a level higher than what a borrower might have achieved with a fixed-rate even if rates in the economy as a whole don’t change. That’s because ARMs have initial fixed-rates that are set artificially low. Once they fully adjust, with a little increase in rates, the advantage of ARMs can be lost in 3 or 4 years.

The first adjustment can be a large one because some ARM loans have periodic caps that don’t apply to the initial change.

ARMs are difficult to understand. Lenders have much more flexibility when determining margins, caps, adjustment indexes and other things, so unsophisticated borrowers can easily get confused or trapped by confusing terms.

On certain ARMs, called negative amortization loans, borrowers can end up owing more money than they did at closing. That’s because the payments on these loans are set so low (to make the loans even more affordable) they only cover part of the interest due. Any additional amount due gets rolled into the principal balance.