Why this article is important: Our economy is primarily supported by the extension of consumer credit — an individual’s use of borrowed money and rented property. MLOs and landlords rely on credit agency information to decide whether to lend or lease to a household.
Credit reporting is an opaque subject for most members of the public who use real estate brokerage services. This article takes a bird’s eye view of the fundamental concept of extending consumer credit, such as lending money or letting property or layaway sales, and how an MLO or landlord uses a credit report, to enable an agent to intelligently inform clients about the effect of their creditworthiness on their transaction.
Credit report matters
An individual’s consumer credit score is intended to indicate a homebuyer or tenant’s probability to repay their debt obligations. Since the score is used by MLOs and landlords, a single three digit score sums up an individual’s debt history in an easy-to-apply number — which mortgage loan originators (MLOs) and landlords need to guide their response to an application.
Accurate credit information in a credit report on the financial behavior of a buyer seeking a mortgage is critical for an MLO to further analyze the risk of default that exists when originating a mortgage. Likewise, landlords use credit information to assess whether a tenant is likely to perform as agreed in their lease agreement — or not.
MLOs and landlords receive an application from a buyer or tenant with a provision authorizing them to pull the applicant’s credit report for use in determining whether the applicant is apt to pay as agreed. [See RPI Form 302]
A consumer credit report is supplied by only three credit reporting agencies, as no other agencies exist. The report contains information about the payment history and credit standing — and the score — of a buyer or tenant. The mortgage or rental application form may require the buyer or tenant to pay for the cost of the credit report. [See RPI Form 202]
Notably, neither the credit reporting agency nor the credit report assures, much less guarantees, the future performance by the buyer or tenant to make payments on the mortgage or rent. More critically, the report content does not address or provide evidence of the buyer’s ability to pay.
The issue of a household’s ability to pay as agreed is resolved on an income and net worth analysis made by the MLO or landlord, separate from credit report information. Ability to pay is confirmed by investigating an applicant’s employment status, wages and assets, then applying a consistent income-to-payment ratio. Generally, MLOs and residential landlords limit monthly payments to 1/3rd of the applicant household’s gross income.
Specifically, a credit report guides an MLO or landlord in their review of the buyer’s or tenant’s past performance for repaying debt obligations. Debt reporting includes amounts of money owed on:
- loans or financing agreements;
- judgments or tax liens; or
- retail and bank credit accounts.
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Understanding the credit score
Most MLOs and landlords rely on an individual’s Fair Isaac Corporation (FICO) Score. This score is calculated by each of the three credit reporting agencies based on reporting by banks, MLOs and credit card issuers. The information is from institutional lenders, called traditional credit sources.
Credit reporting agencies are limited to three operators consisting of TransUnion, Experian and Equifax. As aggregators of debt behavior on individuals, these agencies collect and condense the credit information they receive into a score. Each agency independently calculates the score they issue on an individual from the data they have compiled.
Each credit score formulated from an individual’s debt behavior consists of:
- 35% payment history;
- 30% amounts owed;
- 15% length of credit history;
- 10% new credit opened; and
- 10% type of credit used.
Credit scores range from a low of 300 to a high of 850. Generally, MLOs rank credit scores by tiers of probability for debt performance, such as:
- poor when they are below 580;
- fair when they are between 580-669;
- good when they are between 670-739;
- very good when they are between 740-799; and
- excellent when they are 800 and higher.
Nontraditional credit history
Occasionally, MLOs receive an application from a homebuyer with insufficient credit reporting by financial institutions to the credit agencies — they lack reported borrowing history. Thus, the credit agencies are unable to calculate a credit score. In these cases, the application provides the MLO or landlord with non-reporting creditor sources so they can establish a nontraditional credit history and make a decision based on their judgment, not on an agency score.
Non-traditional credit sources include non-lender creditors the applicant makes payments to, such as:
- landlords;
- utility companies;
- school tuition payments; and
- health insurance companies.
MLOs analyzing nontraditional credit sources to qualify a homebuyer need to process the mortgage application by manual underwriting. This processing extends the approval process as the MLO becomes the gatherer and aggregator of payment history on the applicant for the creditworthiness analysis.
Editor’s note — When any borrower on a mortgage application lacks a credit score due to insufficient creditor reporting, the MLO requests information of the applicant to establish a nontraditional credit history. [Selling Guide B3-5.4-01]
Further, a residential landlord using credit history to establish a prospective tenant’s probability to make rent payments needs to allow for alternative credit reporting when institutional credit history reporting is not available.
This alternative to an agency credit report includes evidence of:
- government payment benefits;
- pay records; and
- bank statements. [Government Code §12955(o)]
Further, the landlord gives the tenant a sufficient amount of time to gather and provide alternative evidence supporting their probability for making payment of the agreed rent. This evidence must be considered by the landlord along with the rest of the application. [Gov C §12955(o)(1)(B)]
To assist tenants to establish traditional credit as reported by agencies, residential landlords in California — including landlords of assisted housing developments — must give tenants the option to have their positive rental payment history reported to at least one consumer reporting agency that resells or furnishes rental payment information to one of the consumer reporting agencies. [Calif. Civil Code §§1954.06; 1954.07(d)]
Editor’s note: While landlords might not blatantly discriminate against prospective tenants by relying solely on reported credit history to an agency, the effect is often discriminatory for those with thin or nonexistent credit histories (e.g., those who are seeking housing after being homeless, or individuals who manage income and expenses without incurring debt).
Residential mortgage applicants or tenants who believe their lack of traditional debt history discriminates against them, not their ability to pay, may file a complaint with California’s Department of Fair Employment and Housing (DFEH). The DFEH then investigates and attempts to resolve the complaint.
When the complaint is not resolved, the DFEH is authorized to file a lawsuit against the landlord to seek monetary relief for the applicant or tenant.
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Mandated landlord credit-reporting offer to improve tenant credit scores
Mortgage-related credit reports
When the sales transaction involves a mortgage of $150,000 or more, whether originated by a MLO or carryback seller, a consumer credit report also contains information not otherwise available in a credit report, regarding:
- bankruptcies predating the report by no more than ten years;
- civil suits and judgments, and records of arrest predating the report by no more than seven years;
- paid tax liens predating the report by no more than seven years;
- accounts placed for collection or charged off as a loss predating the report by no more than seven years; and
- records of criminal activity predating the report by no more than seven years.
Foreclosures remain on credit records for seven years and negatively impact a score between 85-160 points.
Chapter 13 bankruptcies stay on file for seven years, but Chapter 7 bankruptcies remain for ten years.
Both reduce your score by about 130-240 points.
30-day mortgage delinquencies reduce a credit score between 60-110 points, and the impact is higher for 60- and 90-day delinquencies.
Client advice
When a buyer-client seeks pre-approval for a mortgage, advise them to first pull their credit report and review it before submitting applications to MLOs. An individual pulling their credit report does not affect their credit score — nor does seeking pre-approval for a mortgage affect their credit score.
It’s pure logic for a client-buyer to apply with multiple MLOs to find the most competitive terms.
When an MLO rejects an application due to negative credit report findings, the MLO sends each applicant a separate adverse action notice explaining the specific reasons the application was rejected. Alternatively, the MLO may notify the applicant of their right to learn the reasons by a request to the MLO within 60 days after denial based on a credit report. [12 Code of Federal Regulations §1002.9]
When an MLO rejects an application based on the content of an individual’s credit report, the MLO is further required to:
- provide the credit score number and the key factors impacting the score;
- provide the name, address and telephone number of the credit reporting company used;
- explain the applicant’s right to a free copy of the credit report from the credit reporting company used within 60 days of the adverse action notice; and
- explain how to fix mistakes on the report. [12 CFR §1002.9(a)]
When a tenant is denied housing due to credit report findings, the tenant may:
- ask the landlord what information in the report caused the denial;
- ask the landlord for a copy of the report, or request a copy of the report from the company the landlord used — the landlord must give the tenant the name, address and phone number of the agency;
- review the report, check for inaccurate or outdated information, and dispute any errors.
Improving a credit score
To improve and maintain a high credit score, clients need to consider:
- setting up a schedule for periodic bill payments or banking service to ensure payment of bills on time;
- developing a household budget;
- contacting their creditors when unable to make payments to modify the payment schedule instead of becoming delinquent;
- consolidating and paring down debts; and
- pulling a free annual credit report each year at https://www.annualcreditreport.com/ – one every four months from a different credit agency — and confirm all items are correct.
Credit counseling services are useful for clients with little or no credit, or with credit reports containing incorrect information.
However, it does not cost money to have an error removed from a credit report. To dispute an error, individuals may send a written request to each credit reporting agency (Transunion, Equifax and Experian) with evidence of the inaccuracy.
It’s best to also dispute the error at its source. For example, a payment servicer inaccurately claims missed student loan payments. Here, the client needs to contact their student loan servicer to ensure the error is corrected by taking remedial steps with the reporting agencies.
View a list of credit counseling agencies approved by the U.S. Department of Justice.
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