Credit Scores Explained
With mortgage interest rates near record lows, you may want to buy a home before rates go higher. Can you qualify for a purchase loan? Your FICO scores may be the key.
Over 50 years ago, The Fair Isaac Company created credit scoring so that lenders can understand at a glance how much risk you pose as a borrower. “FICO” scores are determined by software that analyzes your job history, credit, income-to-debt ratios, spending habits and payment history.
Credit scores are compiled separately by three consumer reporting bureaus where lenders, landlords, government agencies and others can upload information about you that impacts your credit scores. The bureaus – Equifax, Experian, and TransUnion - calculate scores differently, and base their scores on their own propriatory algorythms. Base scores range between 300 and 850 with 850 being the best.
Your credit score is shorthand for information in your credit report, whether you pay your bills on time, how much you owe creditors, loan payoffs, how many accounts you have open, and derogatory information such as liens. It also includes inquiries into your accounts from lenders, landlords, and employers.
Before you apply for any loan, you should get a copy of your credit reports and scores. You can do so at each bureau for free once a year, or you can pay a fee to get a three-bureau report. You need to check all the information and see if it’s correct, because the bureaus or creditors can make mistakes, you may have forgotten to pay a certain debt, or you may have innocently closed accounts that resulted in a lower score.
This is important because when you apply for a home loan, your application gives the lender permission to “pull your credit” and base the decision to lend to you and establish the rate of interest based on your credit scores. The higher the score, the better terms you’ll receive from the lender. The lower the score, the higher the interest you’ll pay, or you may be required to put down a larger down payment. Your loan could be denied altogether.
Once your credit scores are reviewed by your mortgage lender, you’ll receive a computer-generated report of the findings in the mail, but it won’t have a copy of your entire credit report. It may include key factors that adversely affected your scores. Some examples might include:
Too many inquiries in the last 12 months
Time since most recent account opening is too short
Proportion of loan balances to loan amounts is too high
Too many accounts with balances
Amount owed on revolving accounts is too high
If your credit scores pose a problem, the lender will tell you what you can do to fix the problem.
Prevention is the best cure. To keep your scores as high as possible, pay all bills on time, pay more than the minimum required and reduce your credit card debt to improve your income-to-debt ratio.