Your credit score impacts your ability to get the loan you need at a price that works for you.
Unless you are an all-cash buyer, your credit score (aka ‘trustworthiness’) influences the cost a loan and the ability for you to even qualify to begin with for a lender to give you the money you need to buy your home.
Out of the many types of credit scores out there…ONLY one is the king. Only one score is the only score lenders look at: the real FICO score!
Now matter if you are buying a home in Irvine, Northwood, Laguna Niguel, Orchard hills, Newport Beach, Huntington Beach, Fountain Valley, or Laguna Beach, you should check your credit scores and nurture them as far in advance as possible of the time you plan to buy a home. Whether you are in the market to buy a house or will be buying a house sometime in the near future, now is the time to pay attention to your credit and then maintain it if you haven’t been doing so for a long time
Not only will your credit score effect your ability to get a home mortgage, it may affect your ability to get automobile loans, credit cards, line of credit, etc…. Furthermore, credit scores will effect the interest rates you receive as well as insurance rates and possibly in being hired for a job.
When buying a home with financing, your credit score play a large role on the determination on if you will or will not qualify for a loan, and if you do, what interest rate you shall receive (the “price you pay” for borrowing money).
Lenders use your credit score as a strong clue as to what kind of risk you are to them in your ability to pay by the loan (every month, over the years) and at what interest rate.
In the most simplest of definitions, here’s how the lenders think, and remember, its just business. Nothing personal.
- Low credit score = less trust = high risk of defaulting on loan, so the higher your interest rate.
- Higher credit score = more trust = lower risk of defaulting on loan, so the lower your interest rate.
Higher interest rates are charged to risky people because the bank wants to make as much money from you up-front, as soon as possible, while you are able to make payments. Because if/when your payments become late, you fall behind, you go into default, the lender needs to deal with you to either get you back on course or wrestle the home away from you to sell it and get their money back. Like I said: its just business. Nothing personal.
Lower interest rates are are available to high credit score people since they demonstrated prior and current trust to the lender by the history with other creditors, previous lenders, and therefore those people are seen as much less likely to be late, fall behind, and default. Meanwhile, high credit score borrowers (you, right?) are the preferred people to do business with and since the lenders have less risks in this case, they are more comfortable making money (aka interest) from you over the length of your loan.
There are different types of credit scores calculated by the big three credit reporting agencies (indicated below), but most often the one, true, FICO score (see next section, below) is used by lenders. Any other “credit score” offered by anyone is often not used by lenders. Typically, car dealers use the “alternative” credit scores, determined by different methods from the official FICO score, since the alternative methods of scoring tend to generate of more favorable “credit score” numbers to enable more customers to qualify for a loan to buy a car.
When you even think of buying of home, the first thing to do is get you credit score first (if not only) from www.MyFICO.com since this is the actual score almost all lenders shall use to judge you. You can either do it yourself or have you mortgage officer (or bank) pull your credit while processing a pre-approval letter for you.
UNDERSTANDING YOUR CREDIT SCORE
Credit scores are an expression of your credit worthiness based on a number created by a mathematical algorithm. Credit scores are used by banks, credit cards, stores, etc… to assess risk in loaning you money. Specifically, what is the likeliness of the consumer having a serious default in the next 24 months.
The most common system used for mortgages is the FICO system, which stands for Fair Isaac Corporation. The Fair Isaac Corporation developed the system in the 1950’s and is still the most widely system used. When you are applying for a home mortgage, lenders may be talking about a credit score which technically means they’re talking about your FICO score.
A typical mortgage credit report will be a FICO score from www.MyFico.com. Even though the 3 Credit Reporting Agencies like Experian, Equifax and TransUnion who track some, most, or all of your credit history (if the creditor is a ‘subscriber’ to some, one, or all), they offer their own version of a Credit Score…which lenders may or may not use. The FICO score is used most often, and the other credit score options can and are usually used by department stores, car dealers, and sometimes smaller credit card companies.
The FICO (and sometimes other ‘credit scores’) will typically range from 300-850 with a 600-620 credit score often being the minimum allowed for most types of credit, while people in the upper 500’s may qualify for a some loans but the interest may be very high!
Lower credit scores aren’t always the result of late payments, bankruptcy, or other negative notations on a consumer’s credit file. Sometimes, a consumer who doesn’t have enough information on his/her file will have a low score. This can happen even if you had established credit in the past; if your credit report shows no activity for a long stretch of time, items may ‘fall off’ your report. This is because your credit score must have an update provided by your creditor within the past six months; if you creditor stops updating an old account you don’t use, it will disappear from your credit report and leave FICO with too little information to calculate a score.
Similarly, consumers new to credit will have no established credit for FICO to use when calculating a risk score. If there is just a little bit of information, you may get a score, but it may be low. This low score wouldn’t be because you made any mistakes, but because you are considered a risky borrower since the credit bureaus don’t know enough about you.
Let’s explore the numbers. Credit scores range from 300 to 850, with higher scores being better. Here’s a rough guide to what various score ranges mean:
YOUR FICO SCORE IS:
- Exceptional: 800+ and is made up of 20% of the population;
Credit should be very easy to obtain with the very best rates.
- Very Good: 740-799 and is made up of 18% of the population;
Credit should be easy to obtain with very competitive rates.
- Good: 670-739 and is made of of 22% of the population;
Credit will be accessible to you with fairly competitive rates.
- Fair: 580-669 and is made up of 20% of the population;
Credit will be tighter to obtain and you will start to pay a premium in rates.
- Poor: 300-579 and is made up of 17% of the population;
Credit will probably be not existent to you and if it is available you will pay a heavy premium.
UNDERSTANDING WHAT MAKES UP YOUR CREDIT SCORE
Credit scoring is a complicated algorithm. Complicated enough to make it hard to manipulate. But there are 5 areas that go into making up your credit score and they are weighted depending on importance.
- Payment History– Pay your bills on time and you won’t have any problems. One or two missed payments might be alright but once you get into more late payments and collections it will take a long time to correct.
- Amount Owed– The amount owed versus your available credit. A good rule of thumb is try not to use anymore than 30% of your available credit for one line. Yes, your credit takes a ding especially when 50% of your available credit is used.
- Length of Credit History– The older the credit the better. Your last activity and the date you opened the credit is looked at. You should never close out your oldest lines with out carefully considering the impact. A credit card you have had for 20 years with perfect payment will go a long way.
- Type of Credit– They look at the mix of installment vs. lines and unsecured vs secured debt. There are certain lines of credit that are better than others. If you have lots of lines of installment credit that is usually not looked upon favorably.
- New Credit– You should be very careful opening new lines of credit. If you do want more credit, pace yourself over time and don’t do it all at once.
7 COMMON MISTAKES PEOPLE MAKE WITH THEIR CREDIT SCORE
Here are some simple things people do every day to destroy their credit. If your credit profile is good, don’t do anything to change it without serious consideration and think about hiring a credit consultant company (see final remarks below about this).
- Close Out Old Accounts– As stated above the older the account the better. Closing out old accounts is usually not a good idea especially if it leaves you with just a bunch of newer accounts. You are probably better off paying the line off and leaving it open.
- Being a Co-Signer– Most people don’t really think about it but when you are a co-signer that line of credit, it shows up on your credit. On top of it you have no control how the party you signed for takes care of their end of the line of credit.
- Don’t Use Credit– You may have plenty of credit but if you don’t use it there is nothing to report. The agencies like to see use on the lines of credit. Even if you use it and pay it off immediately and in full that at least is showing good use.
- Max Out Your Credit– Even if you are making timely payments, maxing out your available lines of credit is never a good idea. For every 25% or so you use of a line of credit you take a serious ding. It is best to keep your balances under 30-25% of your limit. Below 10% is great.
- Opening New Cards for the 0% interest rate on balance transfers– This is not a good idea if you are trying to maintain your credit. Constantly open new credit and closing old lines or having too much available credit will temporarily hurt your credit score and no one knows for how long.
- Opening Department Store Credit Cards Just to Get A Discount– Sure, its great to save 10 or 20% on a purchase, but again you are opening a new line of credit. If you are the type of person likes the discount you probably have a slew of department store cards in your pocket. If you think you need that department discount, then maybe you should re-evaluate you ability to afford to buy a home!
- Never checking your credit– Mistakes and fraud happen, more often than you think. Get into the habit of checking your credit score at least once a year to make sure there are no problems. If there is, at least you have time to take care of a problem rather than in the middle of trying to get a mortgage.
OTHER EFFECTS OF YOUR CREDIT SCORE
Speaking of credit scores, did you know that your credit score can effect other things as well?
- Insurance Rates– The rate you are quoted on your home insurance and car insurance will be effected by your credit score.
- Private Mortgage Insurance (PMI)– If you are putting less than 20% down on a home the bank will require you carry private mortgage insurance or PMI. The amount you pay for PMI may be effected by your credit score.
- Housing Rental– When renting an apartment or home your credit will most likely play a large role in having your application accepted. Or not.
- Employment– There are some jobs in the financial fields that may be dependent on your credit score.
As you can see, your credit score can effect many areas of your life. Over a lifetime your credit score, if not optimal, can cost you 10’s if not 100’s of thousands of dollars. Understanding your credit score can help you make some decisions about how you utilize credit, especially with something as large as a home loan.
CHECKING YOUR CREDIT
You can annually pull your credit report for free, once a year from each of the credit bureaus. Go to www.myannualcreditreport.com to get your free, annual credit report. NOTE: Annual Credit Report is the ONLY free source for credit reports authorized by Federal Law. This will not give you a credit or FICO score, but will list what is being reported to the 3 credit reporting agencies.
Look for errors on your reports. It is not uncommon at all to have errors on your credit report. If you have some derogatory credit, research how you may go about rectifying it in the best way possible. By law most derogatory credit is removed after 7 years.
To actually get your FICO score you will probably have to pay for it from www.myfico.com. Realize there are different ways and timing of reporting to credit agencies by your creditors, and when you go to get a mortgage your credit score may be different than what you have pulled in the past.
FINAL THOUGHT ON UNDERSTANDING YOUR CREDIT SCORE
No matter where you are at in life, learn about your credit score and keep making those payments on time. You might not need credit now but you never know when you may need it in the future.
If you and/or your spouse have credit issues, concerns, late reports, negative or false marks or records of any kind on your credit report and you want to buy or sell a home, I have a company that I refer all my clients, who hire me as their agent, that properly address issues, know the credit laws, and how to handle and challenge any non-positive issues or mistakes on client’s reports. This is part of the service and care that I provide as a real estate agent: being connected with good, trustworthy source to help my sellers and buyer be in the best position possible so their transactions of buying and selling may be as smooth and successful as possible!
If you hire me as YOUR real estate agent, my resources become yours! We work together on YOUR goals!