Throughout the years, mortgage rates have varied by loan-to-value and by term only. Items such as mortgages and variation in credit risks were not taken into consideration. A variation in interest rates was typically due to an additional charge for mortgage insurance (PMI) for home loans with loan-to-values greater than 80 percent, or higher rates due to the length of amortization. The exception to this trend became known as sub-prime loans.

Sub-prime lenders are those who specialize in providing loans to borrowers who do not qualify for traditional financing due to credit damage or difficulties in verifying income. These lenders have used a system known as "risk-based" pricing for years. The greater the risk, the higher the interest rate.

A leading credit indicator used for lenders to determine risk-based pricing is the FICO (Fair Isaac Company) Score. Mortgage lenders use FICO Scoring to speed up the loan application process by simplifying the credit review process. In the last two years, Fannie Mae and Freddie Mac have also included FICO Scoring into their credit documentation requirements on prime mortgage loans.

What is a FICO Score?

FICO Scoring is a formula for credit risk assessment which is believed to be highly predictive of the borrowers ability and willingness to repay the loan. The borrower's score is derived by weighing credit information at a snapshot in time and assessing "points" for each piece of information. Information is taken from credit bureau files. The scores are based on credit information only. By law, an applicant's credit worthiness cannot be judged on race, religion, marital status, gender or nationality.

In accordance with Fair Isaac, the information is objective, consistent, and does not discriminate. FICO Scores can, however, fluctuate. Depending on from where the credit collections information is taken and geographical location of the borrower, the information available will differ, which will lead to variations in the scoring.

Computing the FICO Score

The borrower's score is determined by assigning numerical values for certain credit characteristics. The higher the over all score means there is less risk involved for the lender.

Characteristics included in the computation of the score consist of:

• Payment history
• Amounts owed
• Length of credit history
• New credit
• Types of credit use

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