January 11, 2018 4:01 am
When preparing to buy a new home, your credit score becomes more important than ever in getting the best financing available. The huge investment of buying a house impacts your lifestyle and your finances. For buyers, it’s essential to understand how to make a credit score work for you, rather than against you. In this article, we’ll discuss your credit report and credit score and the basics of getting them to work for you. Let’s get started.
Your credit report portrays your level of risk or creditworthiness. There are many credit reporting agencies that collect consumer credit data. Some specialize in specific types of credit and payment reporting, but the three main U.S. credit bureaus are Equifax, TransUnion and Experian. (You may recognize the name Equifax from the 2017 data breach that affected millions of individual credit reports and personal information.) These three bureaus report on account and payment history for personal loans, mortgage loans and credit cards as well as information on foreclosures, bankruptcies, judgments, etc.
How does it work? Bureaus collect information and sell it to lenders, insurance companies, car dealerships, landlords, employers, etc. who will then decide whether to offer loans, accept rental applications, do business with you or hire you. The information is also sold to companies that rate your level of credit risk with a credit score.
You can request a free copy of your credit report once each year from each of these three major credit bureaus. Your request can be for all three reports at the same time through www.AnnualCreditReport.com or you can direct your request to each agency individually throughout the year.
Carefully read the reports to make sure there aren’t any errors. If there are, dispute them and make sure the report is corrected. You can work on disputes with the credit bureau or directly call the company or organization that has reported the error. Be aware that this can be stressful and can take more time than you would like.
Your credit score (sometimes called FICO score) is based on the credit report information and is determined by five financial management categories. They are listed here in order of importance and approximate weight given that category as shown by the percentage:
- Payment history 35%,
- Debt percentage/outstanding balances 30%,
- Length of credit history 15%,
- New accounts/credit requests 10% and
- The type of credit accounts/credit mix 10%.
Each credit bureau may use slightly different weight systems, but this list would be considered typical.
In addition to knowing what’s in your credit report, it’s important to know your current credit score. You can get your credit score along with the credit report or at another site, often for a fee. Check your credit card statement as some credit card companies provide your current score free with your monthly statements.
Why is your score important? It will be a determining factor in many important transactions and requests, such as your ability to get a loan, the interest rate offered, a rental application decision and the cost of your insurance. For instance, when buying a home, a difference in interest rate of .5%–1.5% not only raises your payment, but can have a significant impact on your financial future over the life of a loan.
Credit scores vary depending on your history. With a top score of 850, anything under 600 indicates a risky borrower, while scores over 760 are considered healthy. If you aim for a score of over 800, you should get a significantly better rate which will save you a lot of money over the length of the loan. Run a calculator with different interest rates, and you’ll be amazed at how much more you’ll pay in interest over time with a less favorable rate. The real cost can be shocking.
Improving your score
For the best credit terms, you will want a clean record on your credit history and a high credit score. Generally, if you overuse credit, miss payments and carry high debt balances on several cards, it will result in a lower score. It’s advisable to watch your report for accuracy and monitor your score to maintain it at a favorable level.
If you have what is considered too much debt for your income, you won’t be able to borrow as much; and what you can borrow will be burdened with a higher interest rate. On the other hand, you will rate higher if your credit history shows that you have used credit over a long period of time, paid it off or maintained the balances at a reasonable level.
If you apply for new credit cards, especially from several companies, those companies will check your credit report. It will show up as an inquiry, and especially if there are several in a short period of time, it will negatively affect your score. On the other hand, if you are applying for credit for an auto loan, mortgage or student loan within a short period of time, it won’t count against you. No worries if you are requesting your own credit report—that does not affect your credit score.
If your score is lower than you’d like, you can make improvements by doing some of the following:
- Make all payments on time.
- Pay off overdue bills so they are current.
- Pay off credit card debt or lower the balances.
- Pay down credit cards with higher, close-to-maximum balances.
- Don’t apply for new cards.
- Don’t follow the pattern of transferring debt from one card to another.
- Don’t close old accounts.
- Review credit reports and dispute errors until they are corrected.
- Ask your mortgage professional to help you decide which steps will have the quickest and most significant impact.
When you start thinking about buying a home (or other major purchase requiring financing), take early steps to understand your credit standing. Check your credit history and clear all errors. Missed payments or maxed out credit cards lower your credit score. Focus on correcting these situations. Keep accounts current, lower balances or pay them off if you have time to do so. Going forward, pay all bills on time, conscientiously managing the accounts you have, without opening any new ones.
With some time on your side, you can improve your credit score, enjoy a better interest rate and realize substantial savings. Even if you’re not planning to purchase a home any time soon, checking your credit makes good sense. If you monitor it regularly, you’ll have a better chance of maintaining an advantageous credit history.
Don’t forget to work with your mortgage professional for personalized guidance on credit score impact and improvement. If you have enjoyed this article and gained motivation to control your credit profile, please share it with a friend who might also benefit. Thank you!