It is a question everyone wonders, and one of the first questions people ask when beginning the mortgage process. How important is your credit score? What is that magic number that will ensure you get approved? And what do you need to do to make the mortgage or refinancing process an easy one?
The common assumption is that there is a minimum threshold that your credit score has to be to obtain a mortgage and to get a good rate. The truth is, there is no exact number because the loan approval process is a combination of many factors.
First a little background, the Fair Isaac Corporation (FICO) collects your financial information from three major credit bureaus; Experian, Equifax and TransUnion. The information collected creates your credit report. Your credit information is then analyzed and calculated to produce a score.
Your score is a combination of your credit and payment history, your credit limit to usage ratio, and the amount of inquiries made by creditors. All of these factors determine your FICO score, commonly known as your credit score.
Most mortgage lenders look at scores from all three major credit reporting agencies, and use the middle score to decide if you are approved for your loan, and the rate they will offer you. Remember, the higher the credit score, the better the potential to obtain a lower interest rate.
Errors on your credit report can reduce your score artificially, which could mean a higher interest rate and less money in your pocket. It is important to check your credit report regularly and to correct any errors in the report well before you apply for a loan.
Your score can range from 300-850. The higher the score, the better your ability to obtain loans, credit cards, financing of a home or car, and insurance. Typically, a credit score of in the mid-600’s to mid-700’s is considered average, but having a lower credit score doesn’t always prevent you from obtaining a mortgage.
There are five factors that determine your score, to a varying degree:
Payment history; this makes up 35% of your score, and is reflective of the timely payments made to your accounts. As it is the most important element in determining your score, delayed or missed payments will substantially decrease your credit score.
Amount owed; this makes up 30% of your score, and is reflective of how much you owe in relation to the amount of your credit lines. Owing a lot of money does not necessarily lower your score, rather it is the percentage of credit you have used that matters. Creditors assume the closer you are to your credit limit, the more likely you are to miss a payment.
Length of credit history; this makes up 15% of your score. A longer credit history is generally better. Also, how long your accounts have been open and the amount of time that has lapsed since you last used them can affect your score. The longer an account has been open and has been in good standing, the better it is for your score.
Credit Mix: this makes up 10% of your score. Creditors consider a mix of credit best – installment loans, such as car loans or student loans, and revolving credit, which is typically your credit card accounts.
New credit; this makes up 10% of your score. Opening several new accounts in a short period of time will lower your score. Typically a credit inquiry will remain on your FICO score for a period of two years. The more inquiries you have, the worse your score will be.
When applying for a mortgage, a home refinance loan, or a home equity line of credit, there are several factors taken into consideration. Your credit score is not the sole determiner of the approval process and assigned interest rate. It also takes into consideration the amount of your down payment, when applying for a mortgage, or the amount of equity in your home, when refinancing or taking an equity line. A larger down payment (20%+ of the purchase price) may offset a low credit score.
Additional factors include the type of mortgage loan program you are applying for. FHA and VA loans generally accept lower credit scores than conventional loans.
The bottom line is, when you are considering purchasing a home, talk to a mortgage lender to learn how your credit score will influence your mortgage loan eligibility and rate.
To help boost your score, pay your bills on time, and make sure you pay the minimum amount due. Use a credit card that hasn’t been used in a while to keep it current, even if you charge a minimal amount. Try to keep your credit usage less than fifty percent of your credit lines. Don’t close any old accounts and don’t open any new ones.