When you buy a home, a lender takes a look at your financial background to determine your ability to pay back a loan. And one specific aspect they look closely at is your credit score. But do you know what actually makes up your credit score and how it can affect your homebuying journey?
It can be hard to understand how specific financial decisions increase or decrease your credit score. But this ultimately helps lenders get a solid grasp of your financial history and the way you prioritize your debts. Knowing how lenders look at your score may help you plan better when buying a home.
History of the Credit Score
Credit scores are ultimately a number that shows how likely you are to pay back debt. The modern Fair, Isaac, and Company (FICO®) credit score as we know it today was established in 1989 and is based on consumer reporting from the three national credit bureaus: Experian®, Equifax® and TransUnion®.
FICO® credit scores were created for banks to evaluate creditworthiness, and in the 1970s, denying credit based on gender, marital status, race, nationality, religion and age was banned thanks to the Equal Credit Opportunity Act.
In 1995, Freddie Mac® required all lenders to use FICO® credit scores to determine a borrower’s creditworthiness.
According to Experian®, the following is a breakdown of credit scores from a range of 300 to 850:
Poor: 300 to 579
Fair: 580 to 669
Good: 670 to 739
Very Good: 740 to 799
Exceptional: 800 to 850
What Affects Your Credit Score
So, what factors actually make up your credit score? There are a number of financial decisions you make that may influence this number, and these are broken up into five different categories.
Credit History Length
The length of your credit history takes into account how long specific accounts have been open, the age of your oldest account, the age of your most recent account and the average age of all your accounts in total. In many cases, the older your credit history, the more it may improve.
Payment History
How you’ve repaid your accounts is a huge factor in your credit score since it essentially shows your debt repayment track record. Your payment history tends to be the biggest predictor of your creditworthiness for lenders.
Credit Usage
Your credit usage includes how much you owe on your accounts, how much credit you’re using versus your limit and how many accounts have balances. The amount you owe on your balances can be indicative of how likely you are to take on new debt for lenders.
Types of Accounts or Credit Mix
Your credit mix refers to the different types of accounts you have and can include credit cards or other types of revolving credit, mortgages, car loans, personal loans and more. A good mix of accounts can show lenders your ability to manage different types of accounts.
Recent Activity
Recent activity can include how many new accounts you have, how many inquiries you have and how long it’s been since you opened a new account. Whenever you apply for new credit, you get an inquiry on your credit report, and this can negatively affect your score.
Your Credit Score and Buying a Home
We know that lenders look at your credit score to predict how likely you are to pay back a mortgage. But how else does it affect your ability to buy a home?
Loan Type
Specific home loans have minimum credit score requirements. Depending on your credit score at the time you’re looking for a home, you might be limited in what kind of loan you can get. For example, Federal Housing Administration (FHA) loans typically require a minimum 500 credit score with a minimum down payment of 10 percent.
Interest Rate
Your credit score may also affect the interest rate you receive, as this is the price you pay for borrowing money. In general, a higher credit score can help you qualify for a lower interest rate and help you save money over the life of the loan.
Other Factors
In addition to loan type and interest rate, your credit score could affect how much down payment you’re required to make as well as the private mortgage insurance (PMI) premium you pay if it’s required.
Don’t Disregard Your Credit Score
Credit scores can affect many factors of the homebuying process. If you believe a new home is in your future, make sure you understand what makes up your own credit score, and be cognizant of the financial decisions you make. A “bad” credit score doesn’t have to stay that way forever. You can still take the time to work on increasing your credit score for a better chance at receiving more favorable loan terms and at funding your dream home.
This information is intended for educational purposes only. Products and interest rates subject to change without notice. Loan products are subject to credit approval and include terms and conditions, fees and other costs. Terms and conditions may apply. Property insurance is required on all loans secured by property. VA loan products are subject to VA eligibility requirements. Adjustable Rate Mortgage (ARM) interest rates and monthly payment are subject to adjustment. Upon submission of a full application, a mortgage banker will review and provide you with the terms, conditions, disclosures, and additional details on the interest rates that apply to your individual situation.
