Lenders determine how much home you can afford based largely on your credit score, or you and your spouse’s combined scores.
Your credit score is a numeric score based upon the information contained in your credit report. This credit report contains information on your financial transactions, such as credit cards, loans, and payment histories for taxes, utilities, and sometimes even rent, as well as other information. This information goes back for 7-10 years or more. It allows financial institutions to quickly and objectively evaluate whether you are a good credit risk based on how you handle your past and existing debt.
Scores range from 300 to 850; as a measuring stick, 720 is considered a good score.
The standard model of credit scoring was developed by Fair, Isaac and Company, also known as FICO. They have created the most common credit scoring model that is used by the Big 3 credit companies: Equifax, Experian, and Trans Union. Many people use the term credit score and FICO score interchangeably.
There are five categories that make up your overall score:
Payment History – This is about 35% of your score, the most important area of all. Have you made payments on time consistently? Are there any bankruptcies, liens, or other signs that you’re a risky borrower?
Amounts Owed – This is about 30% of your score, the second most important area. How much do you owe in total? Are your balances at or near the limit? Has there been a change in your spending habits recently? How much new credit do you seek? What is your debt-to-income ratio?
Length of Credit History – This counts for about 15% of your score. How long have you had credit? How long have you had a good credit score? Bear in mind, being an authorized user on someone else’s credit, even if you paid the bill, is NOT establishing a credit history. This begins with your own first credit card, apartment, or loan.
Credit Mixture – This counts for about 10% of your score. If you have only high interest accounts or loans, if you don’t have any credit at all, this can count against you. Higher scoring mixtures include a sample of credit cards, loans, and other types of credit. Financial institutions want to know you can handle multiple payments, and that you’re responsible with all your financial obligations.
Inquiries – This counts for about 10% of your credit score. Have you been seeking a lot of new debt lately? If you have, it’s a red flag, and a lower score, as it may indicate you’re taking on too much, too fast. If you DO need to shop around for a credit card or a mortgage, do it quickly. FICO will not penalize you if there’s a short period of time that your credit is being checked. For example, eight mortgage inquiries made in any 14 day period will count as one inquiry.
Credit Dos and Don’ts:
1. Don’t make large purchases during the mortgage process…even if there’s delayed payments. The total will still count in your debt-to-income ratio…and can change your pre-approval status, so beware!
2. Don’t open a series of credit accounts or take on several small loans to increase your credit history quickly. Remember, balance is the key, and a bunch of new accounts can make you look financially unstable or risky.
3. Do make regular payments and pay down any high balances. Hard work, but worth the increase in credit score.
4. Don’t close a bunch of accounts to “clean up” your credit score. A sudden reduction in accounts can count against you. If you do choose to close an account or two, try to choose a “younger account” as that will raise the age of your average history and improve your score. Closing all the older accounts will count against you.
5. Do check your credit report annually. Errors and identity theft take time to correct, and while you are trying to get a mortgage is NOT the time for lengthy resolutions!
6. Don’t assume that paying off balances at the end of the month will improve your score. While lowering balances is good, eliminating monthly payments on debt gives FICO less to score, and less history of on-time payments…so do pay some balances over time, to keep your score up and your credit history healthy.
An easy way to check on your credit score is to go to myFICO.com. For a small charge, you can order your own score and a report with complete details. Or you can try Credit Karma for free.
