How Your Credit Score Affects Your Mortgage

January 8th, 2012 by Anne West
Categories: Buying a home, Real estate

There are lots of myths and misconceptions surrounding credit scores, how they are used and how to improve them. I recently attended a lunch and learn session at my brokerage put on by National Credit Care and learned some little known secrets to improving your score that I’d like to pass on.

But first things first. Let’s do a little Credit 101 to set the stage:

What is a credit score?
In a nutshell, your credit score is a three digit number that represents the risk that you will default on a loan, using your past payment history as a benchmark. Your score will determine IF you can get financing and AT WHAT RATE. Insurance companies, credit card companies and mortgage lenders all use different models to calculate creditworthiness. Since we’re talking about home loans here, we’ll focus on the FICO (Fair Isaac and Co.) score. A high FICO score means you will have an easier time getting a mortgage at a low interest rate.

How is my FICO score calculated?
There are five components of your score:

Payment history: Do you pay your bills on time? Yes, it matters.
Balances on revolving accounts (you don’t want your balance to be too high as a percentage of your credit limit)
Length of credit history: Longevity is good, so don’t cancel that credit card you’ve had since college
Types of credit accounts (you want to have a variety)
New credit: you lose points when you open a new account

What is considered a good FICO score?
FICO scores range from 300 to 850. 720 is around the median score in the U.S., so anything above that is considered a good score.

How do I find out my score?
There are three credit reporting companies which gather information and assign you a score: TransUnion, Experian and Equifax. By law, you may obtain one free report annually from each of them. Visit www.AnnualCreditReport.com to receive your free credit report. It’s the only free credit reporting website endorsed by the federal government. It really is important to check your credit report, because around 80% of Americans have errors and inaccuracies on their reports, and this can have a major impact on your borrowing power. Checking your report can also alert you to possible fraud or identity theft that you’ll need to take action on to protect yourself.

Important Advice for Home Buyers
If you are planning to buy a home in the near future, start now to get your credit report cleaned up. Get errors fixed. Pay down your balances. Don’t open or close any accounts. And DON’T make any major purchases on credit. Even after you are approved for your mortgage, DON’T buy that new flat screen TV or dining room furniture until after you close on your new home. Your lender may check your credit right up until closing.

Little Known Secrets to Improving Your Score

Not only are you penalized if you have a balance on all your cards but also if you have a balance on none of them. You should actually use your credit (a little) and pay it back promptly.

When you open a new account it hurts you in two ways: you get penalized just for opening the new account, but that new account also reduces your average length history, which makes your score go down.

Pay off your smallest credit card first. You get just as many “points” as if you pay off a big one.

If you’re going to cancel a credit card, cancel the youngest card first (most recently opened). Leave your old cards open, and use them.

Once your credit balance is above 50% of your credit limit, you get penalized more.

A corollary to the point above: request that your credit limit be increased, if you have good repayment history on it. This is NOT so you can use it, but to reduce your credit utilization ratio (i.e., the percentage of your available credit you are using).

You should check your credit score a couple of times a year. But don’t do it too often. Too many credit inquiries (even by you) can hurt your score.

If you are looking for information or advice about the mortgage qualification process, we have some excellent resources that can give you the guidance you need. Just give us a call at 847-881-6657 or drop us a line and we’ll be glad to refer you to one of our trusted mortgage professionals.

Tags: credit rating, home mortgage

This entry was posted on Sunday, January 8th, 2012 at 10:25 am and is filed under Buying a home, Real estate. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.