Last month, we promised to talk about credit scores and how they can impact the cost of your mortgage.
Lenders look at Credit scores as a decisive factor in approving a loan so it is imperative that you start paying attention to your credit score now. Mortgage industry findings show that someone’s credit score is the number one indicator of how likely a borrower is to default on their mortgage. Therefore a lower credit score gets you a higher interest rate while a higher credit score will get you a lower interest rate (we will talk about interest rates and why they matter next month). Since they are so important, how are the scores determined?
Below are the factors that combine to create your credit score and how you can help improve yours now.
- Payment History – payment history, one of the most important factors is in your control. If you have been paying all of your bills on time – keep doing so! If you haven’t, now is the time to make the adjustment so when you do go to buy a home, whether that is in a month or a decade, you will be in a position to buy.
- Amounts Owed – This is a tricky one, but also one where you can be in control. While you want to pay your bills on time, it is not necessarily a good thing to have a zero balance on your accounts. Someone who uses a small percentage of their available credit (note that we said small) but pays their bill on time, might actually get a higher rating than someone who always has a zero balance on their accounts. However, be careful about closing accounts that you do not use. If you have a zero balance on those and they are in good standing, keep them open! It will add to your available credit which is a good thing and also plays into factor #3 below. However , be careful about spending too much of your available credit even if you pay it down on time. They want to see that you use credit, but not overuse it. It is a tricky dance!
- Length of Credit History – Here is where things get more confusing for younger buyers. Many young buyers are surprised when they find out their credit score is not great, despite never having missed a payment on their credit cards or a car payment. Those who are lucky enough to have had a parent purchase a car for them or never had a credit card in their own name until they are out of college are hurt when it comes to credit scores. The length of time you have had established credit is almost as important as paying bills on time. Be sure to keep your oldest credit card open even if you no longer use it so that you can extend the length of your credit history.
- New Credit – Relatedly, be careful about applying for new credit. Opening several accounts in a short period of time can damage your credit history, especially if you don’t have a long credit history. If you need to open new lines of credit, try not to do it all at once and space it out. This also applies to checking your credit. You do not want a lot of credit inquiries into your score. If you are thinking about buying a property, check with a lender at least 6 months in advance so you know your credit score. That way, you can work to improve it.
- Types of Credit Used – Another important factor that can be a detriment to younger buyers is the variety of credit that you have, for example, credit cards, a car payment and a mortgage. For most buyers, their credit score when they go to buy their second home is significantly better than when they purchase their first home if they pay their mortgage on time.
As we mentioned, it is a good idea to keep an eye on your credit scores, but be careful about pulling it too often as your score is often lowered in the short term when it is pulled.
A score of 620 is considered acceptable for obtaining a loan, but you want it to be higher to get the best financing terms. For a non-conforming loan, which is a loan that does not conform to Freddie Mac or Fannie Mae standards, for example a jumbo loan for a more expensive home, you will need a score over 700. Again, you would want it to be higher in order to qualify for a better interest rate, though it is possible to get a loan with a lower credit score and lower downpayments.
If you have any questions about credit scores, please let us know and we would be happy to connect you with a qualified lender who will be able to discuss the process in greater detail.