A credit score is a number that third parties, especially lenders, use to assess the risk of lending you money. The score is one way banks, credit card companies and other institutions determine the likelihood that you can or will be able to pay off any debts you accumulate. A higher credit score indicates that your current financial circumstances and your historical behavior demonstrate a willingness and ability to pay off any loans you may be approved for. This number leaves many individuals asking themselves, how does a credit score work?
The makeup of your FICO score is broken up into a bunch of major factors: Payment History (35%), Debt Burden (30%), Length of History (15%), Types of Credit (10%), and Recent Credit Searches(10%). Let’s take a look at how these components fit into creating your overall credit profile.
Your credit score can impact your mortgage loan in two ways: Whether you can get approved for a financial product in the first place, and what interest rate you may have to pay if you are approved. The higher your FICO score the more likely you are to get approved for a loan, and the better the interest rate associated with that particular loan will be. Lower scores may disqualify you for a product completely or can raise your interest rates significantly.
Given the above components for your credit score, why do consumers have three different scores? This is because there are three different credit bureaus that independently calculate your score: Experian, Equifax and Transunion. While the three companies use very similar processes for determining your credit score, there are small differences in how they’re done. Another complication is that the three bureaus may not all have the same information about you in their systems when making these determinations. This often occurs when an account in your credit history has been reported to one bureau but not another.
Credit Utilization or Debt to Limit ratio is often brought up when discussing the Debt Burden component. It is one of the pieces that make up this piece of your FICO score and is a measure of the total amount of debt on your credit card accounts against the total limit allowed on those accounts. A lower credit utilization, meaning your average balance is lower relative to the total amount you could have on your cards is better for your score.
This ratio can come into play when you might otherwise consider canceling an existing credit card. Even if you don’t use that card, as long as it doesn’t have any fees associated with having it around, your credit utilization figures look better because of the larger total credit limit overall. This also means that requesting a higher credit limit on existing credit cards can help your credit score since it will help lower the overall ratio.
The most common problem consumers face in the payment history component is late payments. Whether it was because you simply forgot or were struggling to make ends meet, being late on a monthly payment for your credit card or a loan will usually cause a negative adjustment on your credit score. How late you were and how many times will determine the adjustment.
The credit history length can come into play when considering how you should deal with something like an old credit card. It may be better to keep it open then close it and lose the good long term credit history.
The best advice we can give is to consult with an experienced loan officer to advise you on what will help you to obtain a mortgage and buy a new home. Involve your lender in the house buying process early on for a more seamless transaction.
Your credit score plays a big role in determining your ability to qualify for a loan as well as how much interest you will pay over the life of the loan. If you are considering buying a house in the near future discuss your options with a loan officer to evaluate your current credit score and discuss your next steps before you apply for any new loans or credit cards or close any accounts. Contact Title Mortgage today to talk with one of our experienced loan officers.