Understanding How Your Credit Score Impacts a Mortgage
Your credit scores have a significant impact on your ability to obtain a home and your mortgage interest rate. With a high credit score, you may qualify for the best available interest rate, which could ultimately mean saving money on your mortgage.
Why do lenders care about your credit scores?
Credit scores help lenders assess risk more fairly than subjectively making these decisions. The scores are consistent and objective. They are reflective of your likelihood to repay debt responsibly, based upon your past credit history and current credit status.
How are credit scores calculated?
The three main credit bureaus — Equifax, Experian and TransUnion — create your credit report, which credit scoring models such as FICO (used by the mortgage industry) use to come up with a scoring range of 300 – 850.
Understanding your credit
Your scores are typically based on whether you make payments on time and how many accounts you have in good standing. Some other factors affecting your credit scores are,
- How long you’ve had credit
- Your credit limits and how much of those limits you are using
- Hard inquiries on your credit report
What elements impact your credit scores?
About 35% of your credit score is based upon whether or not you pay your bills on time. Think about it … would you be likely to lend money to a friend that you know has ignored payments on student loan debt or credit cards? Another 30% of your credit score is based on how much debt you owe, which is why you may consider paying down some debt when contemplating a home mortgage. That said, do not make the mistake of closing all of your credit cards as a short term strategy! Those open accounts are a clear reflection of your credit history and lenders need to see this. Just consider paying the balances down to zero.
What steps should you take when contemplating a home mortgage?
You can go online and pull your free credit report at annualcreditreport.com to check it for errors. There is no need to pay for a credit report before contacting your lender or worry about your scores. This free report will assure the information being reported under your name and social security number is accurate. Correcting any errors you may encounter may raise your scores, so it is a good idea to do so before you apply for a mortgage.
How to avoid a negative impact on your credit scores when shopping for a mortgage
Most credit scoring models are built so you can shop for a mortgage within a certain period of time — typically up to 45 days — with little or no impact on your scores.
Actions to take to improve your credit scores
It’s important to note that repairing bad credit can take time. Beware of any “quick fix” solutions you are offered. Following are some tips to get you started:
- Check your credit report. As mentioned above, correcting any misrepresented data could improve your scores.
- Setup payment reminders and/or pay off collection accounts. Making your credit payments on time is one of the biggest contributing factors to your credit scores. You could also consider enrolling in automatic payments through your credit card and loan providers to have payments automatically debited from your bank account. Although this may not instill a sense of money management, it does assure you the payments will be made on time. Delinquent payments and collections can have a major negative impact on your FICO scores. Please be aware that paying off a collection account will not remove it from your credit report. It will stay on your report for seven years, but paying it off can help your credit scores.
- Reduce the amount of debt you owe. Not only will this help you with money management skills, but the less you owe, as compared to your high balance limit, the better it is for your credit score.
If you are considering a home mortgage, fixing errors in your credit history (if they exist) and then following the guidelines above to maintain a consistent, good credit history are your first steps. This may take patience and discipline, but it will serve you well. Learn more about improving your credit score.
Three Next Steps