As part of our Consumers ConnectU financial education series, Tim Kosak, our Consumer Lending Manager, will be hosting monthly “Ask Tim Anything” chats on our Facebook page. In March, he took your questions on loans. In case you missed it, here’s the play by play.
Q. How do I know I am getting the right type of loan?
A. Some loans have obvious benefits over others. For instance, a home equity loan is different than a car loan—but should you use a home equity line of credit to purchase a vehicle? We partner with our members to make sure their long term plans match the products they are applying for. For example, we’ve seen folks get trapped in interest-only home equity lines of credit because they were lured by the low payment and low interest and the debt outlived the purpose of the loan. In this case, a vehicle purchase. In this situation, you want to make sure the debt will be paid off before you need to borrow again for the next vehicle. Another challenge we’ve seen members come up against in matching the right product to the right need is in taking out a few year loan to pay for an annual vacation, then running into trouble when wanting to take the next vacation.
Likewise, once you have the right loan product picked out, talk with your loan officer about the right term. For example, folks who use their car to drive for a living, like salespeople, may not want to take out the longest term loan available, realizing that the vehicle may require significant repairs during the term or not outlive the loan.
Q. Between secured or unsecured loans, is one better or worse for building up your credit score?
A. The three top factors affecting your credit score do not have to do with the type of credit you have, so both can be beneficial if paid well. That said, I personally like to use a credit card to build credit, because it can help establish longevity of your credit history. If you pay it off every month, you won’t pay finance charges, if you select a card that has no annual fees. FICO has a nice resource showing the factors that influence your credit score here.
Q. I’ve seen that I have different credit scores depending on the company checking my credit. Why is this?
A. We get this question quite a bit. Not only are there different credit score “manufacturers,” but each has different models that they use to calculate your score. Think of this analogy: Microsoft would be one manufacturer, and the company produces several models for Windows (8, 7, Vista, XP, etc.).
A couple of the large credit score manufacturers today are the Fair Isaac Corporation (FICO) and the Vantage Score. Other companies, like Credit Karma, have popped up to help consumers monitor their scores. Each of these manufacturers has a slightly different scoring model. Let’s focus on the most commonly used, the FICO Score. Some financial institutions use a FICO Classic model for some credit requests, while they may use a FICO Automobile model for other purposes. They are both very different scores. The Automobile model gives more weight to how you pay your vehicle loans, whereas the Classic model provides a more general representation of your credit history.
Your main concern would be the direction or the stability of your score, as long as you’re comparing the same model. You want to see it increasing or staying at a high level. This is why models like Credit Karma have gained popularity, even though it may not be the same score used to evaluate your loan application. It can help you keep tabs on the direction your score is moving.
Q. What are the key factors in my loan application that a loan officer looks for?
A. An oversimplification of this is your credit history, debt structure, debt load, and your employment/income information. Credit history is as simple as how you pay your debts, while debt structure relates more to what kind of debt you have. For example, are you carrying a large portion of credit card debt?
We use the stoplight method to compare your total credit card debt to your gross annual income. A 10% ratio is generally considered healthy, while 20% can be cautionary, and 30% or more can be a sign of credit card overload. Debt load, often referred to as DTI or debt to income ratio, is measured by taking your monthly credit obligations (car loan, mortgage, credit card payment) compared to your monthly gross income. Typically, expenses like utilities and groceries are not included. While 36-41% can be a good benchmark to stay below, your unique situation may be far different.
Employment and income are evaluated to determine the stability of your income. Self-employed or commission-based borrowers have the added challenge of demonstrating their income is stable from year to year.
Ultimately, making sure the finance option you choose fits within your budget is the most important step you can take. We find our members very often have the best solution in mind already when they meet with our loan officers. We just help to make it possible! We’re lucky to work with some of the most financially-savvy consumers in our area.
Be sure to join us next month for our Ask Tim Anything ConnectU Facebook Chat on mortgages and your home! Watch our Facebook page for more information.