So you are looking for your dream home, or know someone who is? Did you know your credit score will affect your ability to qualify for the best home loan rates and home loan products? Specifically, a lower credit score might lead to:
- A higher interest rate
- Higher closing costs
- Higher private mortgage insurance (PMI)
That’s why it’s important for you to understand what a credit score is and how your financial activities directly influence your credit score.
Credit scores have different ranges; however, the score that is used by 90 percent of lenders and creditors in this country is known as the FICO® score, which ranges from 300 to 850. The higher the FICO credit score, the better for the consumer. A higher credit score translates into a lower interest rate, which can save a consumer thousands of dollars in financing fees over the life of the loan.
The 5 Factors of Credit Scoring Credit scores are established on these five factors and their varying degrees of importance:
- Payment History – 35% Impact: Paying off debts on time has the greatest positive impact on your credit score. Paying off balances each month rather than only making minimum payments also has a positive impact. Delinquencies that occurred in the last two years carry more weight than older items.
- Outstanding Credit Card Balances – 30% Impact: This marks the ratio between the amount a borrower owes and available credit. Ideally, consumers should keep balances as close to zero as possible, and definitely below 30 percent of the available credit limit.
- Credit History – 15% Impact: This indicates the length of time since a particular credit line was established. A longer credit history benefits borrowers.
- Type of Credit – 10% Impact: A mix of credit, such as an auto loan and a credit card, is more positive than a concentration of debt from just credit cards.
- Inquiries – 10% Impact: Each inquiry made on a consumer’s credit within a 12-month period can deduct points from a credit score. Personal credit inquiries do not impact scores. Score will drop 2-5 points; 45 day window when applying for a specific type of credit – 1st pull drops the 2-5 points, subsequent pulls do not
Credit profiles fluctuate with time based on the factors described above. Bad credit scores are mostly a result of late or unpaid and outstanding bill payments.
The credit scoring system used today was designed in the 1950s to help lenders determine how well consumers can repay a loan in a timely manner. Over the decades, laws have been enacted to establish and maintain transparent credit scoring and reporting practices. For example, the Fair Credit Reporting Act in 1971 established guidelines for fair practices regarding the use of credit scoring. In addition, the Fair and Accurate Credit Transactions Act of 2003 enables each American to obtain one free credit report every 12 months from each of the three main credit reporting agencies: Equifax® Experian® TransUnion® These bureaus have created a central website, AnnualCreditReport.com, to accommodate consumers who wish to do so.
Need to talk to someone about your credit? Need help to get you on track to buy your next home? Or just need to understand how all this affects you? Call me and I will be happy to introduce you to my mortgage lender.