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One of the largest loans an average American will take out in their lifetime is a home mortgage. Mortgage lenders justifiably scrutinize whether entering into a 15 to a 30-year relationship with a borrower is a sound investment. One major component of this analysis is the credit score, which sometimes feels like a financial weapon that looms over every prospective borrower. A low credit score may give pause to a lender as it may raise concerns about whether you would default on the loan, or it may give the lender grounds to charge you a higher interest and premium. But savvy borrowers can use it as a tool to their advantage.Verify your mortgage eligibility (Dec 8th, 2021)
Credit Score 101
So how is your credit score determined? Some of the credit score formulae are proprietary, but a good rule of thumb is the following breakdown:
- Credit payment history (35%): measures whether you have paid your credit accounts on a consistent and timely basis. Also, your past delinquencies, debt collection, and bankruptcies are taken into consideration.
- Debt-to-credit utilization/amount owed (30%): determines how much debt you currently owe relative to the total amount of credit you have available. The "magic" ratio is under 30%. For example, if you have a total of $30,000 in available credit but only $8,000 in actual debt, you would have a ratio of 26%. Anything above the 30% mark is considered a negative factor.
- Length of credit history (15%): examines how long you have had credit accounts that have been open and in good standing. A long history of good standing vouches for your future reliability.
- Different types of credit (10%): having a diverse set of credit lines demonstrates that you can successfully manage different types of credit- ranging from credit cards, mortgages, car, and educational loans, etc.
- New credit accounts (10%): having too many recently open credit lines can signal financial desperation, which in turn also affects your average length of credit history.
Three credit bureaus determine credit scores: Experian, Equifax, and TransUnion. Typically, while there are sometimes variations in scores due to proprietary factors that each bureau use, most credit scores will usually be around the same. An aggregate score ranging from 300 to 850 is assessed, with 850 being the pinnacle. Credit scores roughly break down to the following categories:Verify your mortgage eligibility (Dec 8th, 2021)
- Excellent: 760 - 849
- Good: 700 - 759
- Fair: 650 - 699
- Low: 650 and below.
According to Experian's 2020 Consumer Credit Review, the average FICO score was 710, which is a 7 point increase from 2019 and a 21 point increase from 2010. Average FICO Score Hits Record in 2020, Increases in Every State (cnbc.com)
Three Quick Ways to Improve Your Credit Score
Now that we have an idea of how the credit score sausage is made, let's discuss how you can improve your credit score before purchasing a new home.
1. Pay your bills on timeVerify your mortgage eligibility (Dec 8th, 2021)
Remember, your credit payment history generally accounts for 35% of your credit score. So, this is a crucial way to improve your score. Typically, most creditors do not report delinquent payments until after the 30-day mark (though some may report it earlier). If you have some late bills that can still be paid within that 30-day safe harbor, do not hesitate and get it done! Have your bills be paid automatically each month as many creditors (and even your personal bank) have online functions to auto withdraw bill payments. This way you will never have credit dings for tardiness.
2. Pay down your debts faster
There are few downsides to paying down your debt. With a 30% weight in determining your credit score, this is one of the fastest ways to improve your credit score; less debt improves your credit utilization ratio. Think of each additional debt payment (over and beyond the minimum amount) as ticking down that ratio to work in your favor. Remember, using less of your credit amount is a positive signal to your potential mortgage lender. It shows that you are financially stable, and able to manage debt well.Verify your mortgage eligibility (Dec 8th, 2021)
3. Check for credit score errors
Surprisingly, your credit score may be affected by something that is not your fault. In fact, reporting by creditors is not an error-free process. For example, you may have a common name, say, "John Smith." There may be well over a million "John Smiths" in the United States (actually, we asked Alexa, and she said 44,935). A creditor may erroneously report John Smith of Orlando's missed payment on your account, even though you are John Smith of Los Angeles. Left unchecked, this error may affect your otherwise untainted score. Therefore, it is a good practice to check your credit score to ensure you are not being attributed for someone else's delinquency. You can contact the three credit report agencies and have them investigate the matter. Check out Annual Credit Report.com to access a free copy of your credit reports. If you detect errors, contact the credit agency. The Federal Trade Commission even has a draft sample letter you can use.
The process of buying a new home can feel overwhelming at times, even if you're not a first-time homebuyer. Here at Bydand, you can rest assured knowing that our team will walk you through each step of the process. It is our mission to provide steadfast solutions tailored to accomplish our clients' home financing goals. We'd love to help you get into your dream home. Just give us a call.Show me today's rates (Dec 8th, 2021)