UNDERSTANDING HOW CREDIT WORKS FOR MORTGAGE APPROVAL
Buying a home is a truly thrilling experience, and it’s also one of the most significant financial decisions that you’ll ever make in your lifetime. Understand that selecting a mortgage to pay for your new home is just as essential as picking the home that best suits your needs and desires.
DEVISE YOUR PLAN OF ACTION FOR HOMEOWNERSHIP
Research shows that people who carefully strategize in relation to their large purchases, such as owning a home, are less likely to have financial distress later on in life. With this said, if you’re considering buying a home sometime this year, it’s wise to prepare ahead of time and devise a plan of action. A smart first step is to carefully review and continually monitor your three credit reports. You have one credit report from each of the three consumer credit bureaus… Experian, Equifax and TransUnion. Mortgage lenders will use your credit reports and credit scores as vital factors in figuring out whether or not you qualify for a home loan as well as what interest rate to offer you. The better your credit history, the more likely you are to receive a favorable interest rate on your mortgage loan. If there are mistakes on your credit reports, you may have a challenging time qualifying for a home loan. So, now’s the time to conscientiously examine your three credit reports, search for errors and take the necessary steps to rectify them.
UNDERSTANDING THE IMPORTANCE OF YOUR CREDIT REPORTS
Your three credit reports reveal detailed info about your credit such as the status of your credit accounts and your payment history. These credit reports are an integral part of the decision-making process for your mortgage lender. As previously stated and well worth repeating… your mortgage lender uses these reports to assist them in determining if they will lend you money and at what interest rate. Credit reporting agencies (a.k.a. credit reporting companies or credit bureaus) are the ones who compile these reports. Your credit scores are numbers based on the detailed info found in your credit reports, so let’s now find out all about your credit scores.
UNDERSTANDING THE IMPORTANCE OF YOUR CREDIT SCORES
The calculation of your credit scores originate from the use of mathematical formulas known as models (a.k.a. sophisticated credit scoring algorithms). A scoring model is what mortgage lenders use to predict how probable it is that you’ll pay back a home loan on time, and a large majority of mortgage lenders use a specific scoring model called FICO® when analyzing whether or not to offer you a home loan and when setting your rate and terms. FICO stands for the Fair Isaac Corporation, and FICO® was the pioneer in developing a method for calculating credit scores based on info collected by credit reporting agencies. Your FICO scores will vary depending on the credit bureau and the FICO® scoring model your mortgage lender uses. You have three FICO scores… an Experian FICO® score, an Equifax FICO® score, and a TransUnion FICO® score. These following two things are noteworthy to mention. 1} As the info in your credit reports change, your credit scores also change. 2} While you have only three credit reports, you can have numerous credit scores based on each report.
HOW DO I GET MY REAL SCORE?
According to Experian, “Similarly to how you don’t have just one score, you also don’t have a “real” score. Suggesting there is a real score implies you have scores that aren’t real or are, otherwise, fake. As long as a credit score is commercially available and used by lenders, it’s certainly a real score, as it can influence lender decisions. Having said that, lenders can pick and choose which scores or credit reporting agencies they’ll use for their underwriting processes. The one notable exception is the mortgage industry, where the Federal Housing Finance Agency mandates the use of all three of your credit reports and three FICO® Scores.”
WHAT FIVE FACTORS DETERMINE YOUR CREDIT SCORES?
In summary, when you apply for a home loan, your mortgage lender will evaluate your credit scores to aid them in gauging your financial stability and thus the risk of you defaulting on a financial responsibility. The better your credit scores, the greater your opportunity is to receive an approval for a mortgage. FICO® scores range anywhere from 300 to 850 points. In most cases, mortgage lenders consider FICO® scores of 650 or higher to be fair, FICO® scores of 700 or higher to be good and FICO® scores of 750 or higher to be exceptional. The five primary factors that affect your credit scores include your payment history, the amount of debt you owe, how long you’ve been using credit, your new or recent lines of credit, and the types of credit you use. Each one of these five factors has a lesser or greater impact in relation to your FICO® scores.
FIVE FACTORS THAT COMPRISE YOUR CREDIT SCORES
YOUR PAYMENT HISTORY
Significance… 35%
Your payment history reflects how consistent you’ve been with making your payments on time, and it’s essential to be cognizant of it as this factor is the principle contributor to your FICO credit scores.
AMOUNT OF DEBT OWED
Significance… 30%
Your credit usage, particularly as represented by your credit utilization ratio, is the second most important factor in your FICO® credit scores. Your credit utilization ratio calculation (CURC) goes like this… divide the total revolving credit that you’re currently using by the total of all your revolving credit limits. This ratio is a representation of how much of your available credit you’re utilizing, and it can provide a snapshot of how reliant you are on non-cash funds.
AGE OF CREDIT HISTORY
Significance… 15%
Generally speaking, the greater length of time you’ve had your credit history, the higher your FICO® credit scores. The age of your credit history encompasses the age of your oldest credit account, the age of your newest credit account and the average age of all your accounts. The basis for the age of your credit history is the total length of time you’ve had credit accounts open in your name. If you’ve had any credit cards open for a substantial period of time, it’s wise to continue using them responsibly so that you maintain positive FICO® credit scores.
NEW LINES OF CREDIT
Significance… 10%
The number of credit accounts you’ve recently opened, as well as the number of hard inquiries lenders make when you apply for credit, has a negative impact on your credit scores. Too many accounts or inquiries can indicate increased risk, and as such, they can definitely harm your FICO® credit scores.
CREDIT DIVERSITY (CREDIT MIX)
Significance… 10%
Taken into consideration by credit scoring models are the types of credit accounts and how many of each you have. If you have a diverse portfolio of credit accounts (such as an auto loan, student loan, credit card, et cetera…), a mortgage lender may view you as less of a credit risk. The reasoning behind this is that they’re seeing you as demonstrating an ability to successfully manage varying types of credit and the payment systems associated with them.
IT’S CRUCIAL TO FOCUS ON YOUR REPORTS
The wiser move is to focus your attention on checking your three credit reports rather than focusing your attention on your numerous credit scores. With this stated, carefully review your credit reports to verify that the following info is correct… your full name, your Social Security number, your phone number, your current mailing address, your previous mailing addresses, your marital status and your employment history. Be on the alert for accounts that you do not recognize, accounts that are listed more than once, accounts that you’ve closed yet they’re showing as open accounts, incorrect current balances, incorrect negative account info (such as missed payments and late payments) and negative account info (such as missed payments and late payments that are older than seven years). Closely examine the sections entitled… “Inquiries that may impact your credit rating,” “Inquiries shared with others,” and “Negative information” (pay special attention to bankruptcies, judgments, tax liens, civil lawsuits, accounts placed in collection, and the age of each). Be on the lookout for and be sure to immediately report any mistakes, fraudulent activity, along with any inaccurate, incomplete, and outdated information.
SPECIAL ATTENTION… GET YOUR FREE WEEKLY CREDIT REPORTS
Through December 31, 2022, Experian, TransUnion and Equifax are offering all U.S. consumers free weekly credit reports via AnnualCreditReport.com to help you protect your financial health during the sudden and unprecedented hardship caused by COVID-19.
Want to talk credit as it relates to getting you a mortgage? I’m just a phone call, text or email away.
Paul@MortgageMasterySecrets.com