Your eligibility for many financial products is largely determined by your credit score, especially when it comes to buying a home. For example, your mortgage interest rate can be heavily impacted by your credit score. A high credit score will likely qualify you for a lower interest rate and help you to save money on your mortgage.
Let’s break down the role of a credit score and how it can impact your home mortgage.
Why do lenders care about your credit scores?
Credit scores help lenders assess risk fairly. The scores are consistent and objective and they are reflective of your likelihood to repay debt responsibly, based upon your past credit history and current credit status. While your credit score isn’t the only factor your lender will use to evaluate your homebuying eligibility, it’s one of the most important.
How are credit scores calculated?
Credit scoring models like FICO use your credit report from the three main credit bureaus, Equifax, Experian and TransUnion, to come up with a scoring range of 300-850. While there are several types of credit scoring models, FICO is most commonly used by the mortgage industry.
Your FICO credit score is calculated based on five major components:
- Payment history
- Amount owed
- Length of credit history
- New credit
- Credit mix
What elements impact your credit score the most?
About 35% of your credit score is based on whether or not you pay your bills on time, making it the most important factor in your score’s calculation. Another 30% of your credit score is based on how much debt you owe, which is why it’s important to consider paying down some debt before purchasing a home.
What steps should you take when contemplating a home mortgage?
You can go online and pull a 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. This free report will assure the information being reported under your name and social security number is accurate. Correcting any errors you find may also raise your scores, so it is a good idea to do so before applying for a mortgage.
What actions can improve your credit score?
It’s important to note repairing bad credit can take time. Beware of any “quick fix” solutions offered. The following tips can help:
- Check your credit report. As mentioned above, correcting any misrepresented data could improve your score.
- 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 score. You could also consider enrolling in automatic payments through your credit card and loan providers to have payments automatically debited from your bank account. This ensures the payments will be made on time. Delinquent payments and collections can have a major negative impact on FICO score. 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 compared to your high balance limit, the better it is for your credit score.
If you are considering a home mortgage, pay attention to your credit habits and understand how your credit score can impact the homebuying process. By taking active steps to better your credit or keep your credit score high, you’ll soon be well on your way to homeownership.
*Please Note: There are external links included in this article that will take you to a website that Bankers Trust does not control. Bankers Trust has provided these links for your convenience, but does not endorse and is not responsible for the content, links, privacy policy, or security policy of external websites.
