Before you go too far down the house-hunting rabbit hole, you’ll want to make sure you can qualify for a home in the price range you want. Though many factors go into this, your credit score is definitely one of them!
We know … getting “rated” can make you feel like you’re back in school. Just like in school, however, with a little hard work, discipline, and dedication, you can raise that credit score in no time!
So let’s jump right in, starting with the obvious.
What Is a Credit Score?
A credit score is a number between 350 and 850. This scale was created by the Fair Isaac Corporation, also known as FICO. Your credit score provides a snapshot of your credit history to lenders, essentially summarizing the risk of lending to you.
A higher credit score tells a lender you’re a lower risk, which can make you a more attractive borrower when you’re buying a house. That’s because a high credit score and a strong credit report imply that you can manage your credit wisely and make payments on time. Lenders are more likely to offer you a lower interest rate if you are a high-credit-score (low-risk) borrower.
What Determines Your Credit Score?
There are five factors that help calculate your credit score. These credit scoring models include:
1. Payment History (35% of Your Overall Score)
Paying your bills on time—including credit cards, car loans, student loans, medical bills, and any personal loans you may have—can increase your credit score. In the same vein, late payments can negatively impact your credit score. The credit scoring model will consider the frequency and severity of these late payments, with a 90-day late payment, for example, having a larger negative impact on your credit score than a payment that’s 30 days late.
2. Utilization Rate (30% of Your Score)
The ratio of your credit balance to your available limit is known as the utilization rate. The utilization rate of your individual cards, as well as your overall cumulative available credit, is considered in this factor. A balance-to-limit ratio below 30% may improve your credit score, while a ratio above 30% may have a negative impact.
3. Length of History (15% of Your Score)
The age of your accounts matters. What we mean is it pays to establish a long history of credit usage and on-time payments. Credit accounts that have been open and utilized for years can have a positive impact on your score. It pays to keep these accounts open—even if you’ve paid them off—as they can buoy your score.
Many people use their credit cards for their monthly expenses, which earns them perks and helps establish their reputation as a responsible borrower. This is a good idea only if you know you can pay your balance off every month and won’t find yourself putting additional purchases that you can’t afford on the card.
With this in mind, it might make sense to open a bunch of new credit card accounts, just as long as you pay off the balance at the end of the month, right? Not quite. Opening a new credit account actually lowers the length of your credit history.
This can result in a lower credit score in the first 12 months. Once that account reaches 24 months or longer, however, it turns into a more established length of credit. That’s when you can expect to see a positive impact.
This is also the reason why lenders tell potential homebuyers not to open any new lines of credit when they’re preparing to buy a home. It can lower your credit score and potentially affect your debt-to-income (DTI) ratio.
4. Type of Credit (10% of Your Score)
Also known as credit mix, this credit scoring model takes into consideration what types of credit you have. Generally speaking, a mix of different credit types is considered more favorable than only one credit type. Various types of credit may include a revolving credit card, auto loan and an installment loan, for example. This mix of credit types can produce a higher score than using revolving credit cards.
5. Inquiries (10% of Your Score)
When a lender pulls your credit, it is considered a “hard” inquiry. That can have a negative impact on your credit score. That means every time you apply for a new credit card or loan, you could be dinging your score.
Now, not all inquiries negatively impact your credit. “Soft” inquiries, such as a potential employer checking your credit, aren’t detrimental. Multiple inquiries on a single new account, such as multiple credit checks for your mortgage, ding your credit score only once, as long as these checks are all made within 45 days of one another.
What if you want to check your own credit? Any request regarding your personal credit is considered a soft inquiry and won’t count against you.
What Are the Credit Score Requirements to Buy a Home?
Every lender is different. There’s no magical number that will suddenly unlock the lending world … but there are credit score ranges that lenders generally view more favorably than others.
Credit scores are typically viewed as:
- 800–850: Excellent
- 700–799: Very good
- 680–699: Good
- 620–679: Fair
- 580–619: Poor
- 500–579: Bad
- 499 and lower: Very bad
Going back to that whole rating system, this means someone with a “very good” credit score of, say, 720 could be offered an interest rate considerably lower than someone with a “poor” credit score of 587. While both people may qualify for a home loan, the person with the higher credit score could potentially pay significantly less in interest for their loan.
Each lending institution has its own strategy, including the level of risk it finds acceptable for a given credit product. So keep in mind that there is no standard “cut-off score” used by all lenders.
Plus, don’t forget: When it comes to qualifying for a loan, your credit score is only one part of the equation. A borrower can have a perfect 850 score, but if their income and DTI ratio don’t support the loan amount they’re requesting—say they make $30,000 a year and are looking at homes in the $800,000 range with no other liquid assets—their desired amount can still be denied.
How Do You Check Your Credit Score?
Now that you know everything there is to know about credit scores, how do you check yours? Valid question. We’ve been waiting all article for you to ask that!
You can request a free copy of your credit report once a year from each of the three credit reporting bureaus: TransWestern, Experian, and Equifax. You can contact these bureaus directly or go to http://www.annualcreditreport.com/ to get all three at once.
This is a solid strategy if you’re looking to buy a home in the next three months. If you have some time and want to make sure your credit is improving, you can always request one report from one bureau every four months to track your progress.
Once your credit report is in hand, be sure to review it for accuracy. Call the bureau if you find any errors, or if you have questions about anything in the report.
How Do You Improve Your Credit Score?
If you find that your credit needs some work, remember the five factors that determine your score, and then set about optimizing your credit!
The most effective ways to do this are:
- Making payments on time, every time
- Paying credit cards down to 30% or less of their limits
- Limiting the number of accounts you apply for at one time
- Leaving established, older accounts open even if they’re paid off
Keep in mind, too, that you might be able to qualify for a home loan even if your credit score is in the “poor” to “fair” range. That’s because credit is not the only factor considered.
APM’s specialty programs can help individuals re-enter the housing market who have previously had a short sale, pre-foreclosure, or foreclosure. There is no need to count yourself out of the housing market just because your credit score is less than perfect.
If you have questions about your credit or would like to learn more about the homebuying process, click here to connect with an APM Loan Advisor in your area.