Ask John:
The Worst Advice Ever

Background

Please meet Rachel, Mary and Terry. These folks vary in age from 26 to 49, live all over the country, have different types of jobs and incomes, don’t know each other and have nothing in common…or so we thought.

What we did find out is that they do have one thing in common. Over the past 24 months all of them have applied for a new mortgage loan or refinanced an existing mortgage loan. As such, they all applied for credit, had their credit reports pulled and had their credit scores calculated.

After talking to them it became pretty clear that they also had been given advice from someone on how to improve their credit scores. In these cases the advice came from mortgage brokers and a friend who worked at an auto dealership.

Rachel's Dilemma

Rachel wanted to buy a new home after she moved to the West coast from North Carolina. She had relocated to San Diego and was quickly learning that “wow, homes out here are expensive compared to Charlotte.”

No worries. She and her husband had great jobs in the financial services industry and, while they didn’t want to spend $875,000 on a fixer upper, they needed a place to live.

They went to a reputable mortgage broker in the area and were offered different types of loans. They settled on an interest only loan, which would have given them a monthly payment of $3463 per month at a 5% rate and a 5% down payment. The fact that the homes in their area were appreciating at an average of 16% each year made them feel comfortable with the risky loan.

Rachel and her husband filled out the application and provided the requisite documentation proving their income and employment status.

The mortgage broker pulled their credit reports and credit scores. Her husband’s scores were great. They were all above 775, which easily qualified him for the best loan program. However, Rachel’s scores were a bit of a surprise. Her highest score was a 725 and her lowest score was a 678. In the mortgage industry lenders always use your middle score and her middle score was a 685. A 685 is substantially lower that the U.S median score and wasn’t even close to qualifying her for the best interest rate.

The best they could qualify for with that kind of score was a 6.75% interest only loan. At that rate her monthly payment would have been $4675. That’s a difference of $1212 each month. Ouch!!

Well this changed everything. Not only was this a shock to her but also it basically put them out that the market for the home. Rachel was shocked to learn that her scores weren’t as high as her husband’s scores. She never missed a payment in her life.

She and her mortgage broker went over all of her credit reports to try and identify what was keeping her scores from being higher. After careful review her broker advised her to close all of the credit card accounts that she wasn’t using in an effort to increase her scores. Believing that her broker knew what he was talking about she contacted seven different credit card companies and had them close the accounts.

Since it takes roughly 30 days for the credit reports to reflect this type of change she and her husband waited patiently. It wasn’t a big deal to wait because at the time the mortgage interest rates were trending downward.

30 days went by and the mortgage broker re-pulled her credit files and scores. Expecting a significant increase in her scores she and her broker were actually making fake bets on how many points her scores would increase. Would it be 30 points? Or maybe they would improve by 50 points or maybe even more. In order to qualify for the 5% rate she only needed to improve her middle score by 40 points.

“I bet they’ll go up by at least 75 points each”

Rachel’s broker was very optimistic that his advice was going to save his client’s loan.

Once her reports and scores were delivered the tone in the room completely changed. Not only had her scores not improved, they all had gone down. And, the most important middle score had gone down by 57 points. In a matter of 30 days her loan had gone from “tentatively approved pending further review” to “sub-prime.” The best rate she would qualify for now would be 12.9%. Her monthly payment would be $8935.

What Rachel’s broker didn’t know was that having open and unused credit cards actually helps your credit scores by helping control the overall utilization of revolving debt. Once those cards were closed they could no longer help her. The utilization on her remaining open credit card accounts spiked and caused her scores to plummet.

Bad Advice #1 – Closing credit cards will help your credit scores. This couldn’t be further from the truth. It might make common sense that having a lot of open credit cards can cause a consumer’s score to be lower but in fact it’s the exact opposite.

It’s the difference between what makes “common sense” and what is a statistical reality. In Rachel’s case she took the advice of someone who really was just using common sense and guessing that closing the unused accounts would help. This is very dangerous. And, she learned the hard way.

Rachel was unable to close on her loan and she and her husband lost the house to another buyer.

Mary's Dilema

Mary was trying to refinance the mortgage loan on her house in Roanoke, Virginia. The rates had come down and she was ready to save some money.

In her case her home had a little over $250,000 remaining to be paid off so when she refinanced she was going to lower her payment by almost $275 each month. She could definitely use this money to go toward her retirement and maybe even a new car.

Mary applied for a new loan to refinance her existing home loan and after pulling her credit reports and scores she learned that her middle score was just high enough to qualify for the best interest rate. Her middle score was a 730, which was 5 points high enough to qualify.

“Whew, that was close.”

She didn’t realize how close she was. Five points in a credit score can easily be lost if you’re not careful.

Her broker advised her that they would likely pull another set of credit reports and scores just before closing. Mary asked if she could go ahead and start applying for credit at a few banks so that she could get pre-approved for a car loan.

Her broker felt very confident that a few inquiries into her credit reports wouldn’t cause her score to go down. He advised her to “keep it to less than 7 and you’ll be fine.” That gave her plenty of opportunities to shop around for different loan rates and several dealerships in the Roanoke area.

Thinking that her broker knew what he was talking about Mary began shopping for a car loan that weekend. She even admitted that she was more excited about a new car than she was about refinancing her home loan. Who can blame her, right? Everyone likes a new car.

She heeded her broker’s advice to the letter. She applied for credit with exactly 7 lenders, some banks, a credit union and a few captive automobile lenders. Captive lenders only loan money to consumers who want to buy their manufacturer’s car. So, for example, Ford Motor Credit who loans money on Ford products is a captive lender.

Mary was satisfied that she had seen everything she wanted and decided to buy a brand new Ford Explorer. She was very pleased.

Forty-five days after Mary applied to refinance her home loan, and 38 days after purchasing her new car, the mortgage broker called with some disturbing news. When he pulled her credit reports the second time, as he had said he would, her middle score had dropped by 27 points.

Mary was still able to close on her mortgage loan but her interest rate had gone up by 1%. She still saved money over her previous loan but instead of $275 it was only $40. It was hardly worth the effort and considering the fact that she had just borrowed $19,000 on a new car she was actually paying much more each month on her loans than before she refinanced.

Bad Advice #2 – You can predict the impact of inquiries to credit scores. No, you simply cannot do that. The reason is that inquiries don’t have a specific point value. They are measured in groups and even then the impact will be different to everyone because their value is measured as they relate to the rest of information on your credit reports.

Terry's Dilema

Terry’s situation was similar to Rachel’s. He had moved to a new city and wanted to buy a new house. After month’s of deliberate searching he settled on a new house just outside of the Tallahassee area.

A friend who worked at an auto dealership told Terry that he should know what his credit reports and scores looked like before he applied. This is excellent advice. Everyone should check his or her credit reports several times a year to be sure all of the information is accurate.

The friend went one step further and even volunteered to pull Terry’s reports and scores using the dealership’s accounts with the credit reporting agencies. Terry liked the idea of saving a few bucks (getting your reports is free at least one time per year but getting your scores is never free) so he told his buddy to go ahead and pull them.

Terry’s scores were good enough to qualify for a loan and he knew he wouldn’t have any problems. So, he went ahead and applied for a home loan with a nationally recognized mortgage company a week later.

His scores were very strong and he easily qualified for the best rate the lender had to offer. But, the inquiry from the auto dealership was on all three of his credit reports and his mortgage lender wanted to know if he had gotten a new car loan that just hadn’t appeared on his credit reports. Terry’s first reaction was “why does it matter?”

What Terry didn’t realize is that a new auto loan would change his debt to income ratio and the mortgage lender wanted to know why he hadn’t disclosed this as a debt on his application.

Terry explained that a friend of his who worked at a dealership pulled his credit reports a week or so earlier so he could get his scores for free. Simple enough, right? Not even. He had to write a signed letter to the lender promising that he had not applied for a car loan. He now realizes that it would have been in his best interest to get his credit reports and scores from a legitimately recognized source and spend a few bucks rather than using an account at an auto dealership, which is set up specifically to pull reports for auto loans.

Bad Advice #3 – It’s ok to get your credit reports and scores from a buddy who works for a lender or dealership. Whenever a lender pulls a credit report it posts an inquiry that is specific to that company. So, if Joe’s Bank pulled a credit report the inquiry would say “Joe’s Bank.” The assumption is that an inquiry made like this would be for the purposes of extending credit.

A mortgage loan is very complex to underwrite and lenders don’t like to see things like missing information on an application. If Terry had really been applying for a loan at the dealership then that would have been easy to explain. But, he and his friend pulled a fast one to save a few bucks and in this case it almost came back to burn him.

Summary

While there is much bad credit advice floating around these three examples seem to be among the most common.

The reality is that people who aren’t doctors shouldn’t give medical advice. People who aren’t tax professionals shouldn’t be giving tax advice. People who aren’t nutritionists shouldn’t give advice on the best foods to eat. And, people who don’t have significant experience in credit reporting and, more importantly, the credit scoring industry absolutely shouldn’t be giving advice on how to improve credit reports and credit scores.

Take any advice given by someone outside of the profession with a huge grain of salt. If they didn’t build the credit scoring models then they have no business giving people advice on what will and will not cause scores to go up or down.

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