For many potential home buyers, understanding credit can be a confusing puzzle to solve. We'll try to help you put the puzzle together from the perspective of getting approved for a home mortgage.
The first step in securing financing for your next home will be a review of your credit. The lender will evaluate your credit score, payment history, balances carried, length of credit history, and types of credit. A not-so-good credit score can disqualify you for a mortgage if you do not meet the lender's minimum credit standards, it can affect your interest rate, and can raise your insurance costs.
Credit scores are comprised of five weighted factors:
- payment history (35%)
- balances (30%)
- length of history (15%)
- type of credit (10%)
- new credit (10%)
Let's take a closer look at these components and some strategies to improve your score.
The three major credit bureaus, Equifax, Experian, and TransUnion, use various formulas based on the Fair Isaac Corporation credit scoring system, known as FICO, to calculate your credit score. FICO scores range from as low as 309 up to 850. We recommend that you review your credit reports from all three major credit bureaus on a regular basis to discover errors and get them rectified. You can receive FREE credit reports once per year from all 3 by visiting https://www.annualcreditreport.com/index.action
Payment history (35%)
Paying your bills as agreed is the most important factor regarding your credit. If you have late payments, collection accounts, and negative public records, such as bankruptcies, foreclosures, and judgments, all of these items can significantly drop your score. The most recent 12 months will have the most impact. To raise your score, pay your bills on time all the time and clear up any collection activities. Bankruptcies, foreclosures and judgments are more difficult issues to get beyond. You may need to wait a few years for these items to drop off your report with some lenders. You can usually qualify for an FHA loan once a bankruptcy has been dismissed for 2 years.
Account balances (30%)
High balances on revolving lines of credit (credit cards) can have a significant impact on your score. Often, paying these balances to under 30% of their credit limit can raise a credit score in a short period of time.
Length of credit history (15%)
The longer the account is open, the better the score. It is better to keep a small balance on accounts that have been open for a longer period of time in order to maximize the credit value on these accounts.
Types of credit (10%)
A mixture of credit types will also increase your credit score. At least one revolving line of credit will have a significant impact on your credit. Short-term loans such as Pay Day loans, "no payment until" loans, and the like should be avoided.
New Credit (10%)
Recently opened credit with less than 12 months' history and numerous credit inquiries can also have a negative impact on your score. In preparing for a home purchase, avoid opening new lines of credit or having a lot of people pull credit.
Generally, a credit score in the 640+ range will help you qualify for a mortgage, although the average credit score for approved buyers is closer to the 720 range. We have seen loans approved for buyers with credit scores as low as 580 using an FHA-backed mortgage product, but this is not the norm.
Once you have checked your credit score on your own, then it is time to talk to a real estate agent and a lender to get the expert advice you need to have a successful home buying experience. Please contact us. We will answer your questions and put you in touch with a reputable lender who will help you find the best loan program to fit your unique circumstances.
By solving the credit puzzle, you will be able to unlock the potential to home ownership.