WHAT FACTORS DETERMINE A CREDIT SCORE?
Credit scores are made up of 5 primary factors, all weighted by a percentage. The most influential factor, making up 35% of your credit score, is payment history. Your payment history allows lenders to see how capable you are of making your payments on time. If you are frequently late and/or miss payments, your credit score and credit worthiness will be negatively affected. This could make it more difficult to be approved for a loan or only allow you to qualify for loans with higher interest rates. The second factor, making up 30% of your score, is credit utilization. Typically represented in a ratio, this is the amount of credit you are using in relation to the total credit you have available to borrow. Fifteen percent of your credit score is based on the length of credit history you have established. This gives lenders a large scope to see how well you have handled credit in the past. The fourth factor, inquires and new credit, contributes to 10% of your overall credit score. Too many “hard hits” (ie. applying for a new credit card or loan) can negatively affect your credit; especially inquiries done in a short timespan while in the mortgage process. The final 10% of your credit score makeup is diversification. Diversification takes into consideration the variety of debt you hold – installment loans (mortgages, auto loans, student loans) and revolving credit (credit cards, HELOC’s). This shows your ability to manage the different types of loan products.
WHAT IS THE MINIMUM CREDIT SCORE NEEDED TO BUY A HOME?
Now that we know what factors make up your credit score, you are probably wondering if yours is high enough to qualify for a mortgage. The required credit score varies depending on the loan type. For instance, some programs like FHA* will lend to borrowers whose credit scores are in the 500s, since FHA loans are insured by the Federal Housing Administration. Most conventional loans require you to have a minimum score of 620 to qualify but be forewarned that if your credit score is on the lower end, your interest rate will be higher and you may be required to make a larger down payment than the standard 3.5%. If you are looking to buy a home, but have been turned down by retail banks, chances are that speaking to a mortgage professional from Family First Funding LLC will give you a better idea of options you have, based on the wide array of niche loan programs we offer.
HOW CAN YOU IMPROVE YOUR CREDIT?
Knowing the 5 factors that determine your credit score, you can take some easy steps to help improve your credit. Since payment history makes up the largest portion of your credit score, make sure you are making your payments on time. If you do not already have your bills set on auto-payments, this might be a great option. Whether you want to pay the minimum payment each month or more, having autopay set up will ensure your bills are paid on time and improve your credit score. Keeping your credit card utilization ratio below 30% will also help improve your score by showing that you are not reliant upon your available credit. This means using less than 30% or less of the credit available to you. For example, if your total credit limit is $15,000 your credit balance should be less than $4,500 each month. People often think it’s best to close out zero -balance credit cards, but that is not recommended! By closing credit cards, you are actually increasing your debt utilization ratio and essentially hurting your overall credit score. Additionally, if it is a card you’ve had for a long period of time you are potentially shortening the length of your credit history. Reviewing your credit report for inaccuracies and fraud is always a good practice, especially considering that one-in-five people have an error on at least one of their credit reports – Experian, Equifax or TransUnion. You can get your free annual credit report by visiting annualcreditreport.com or by clicking here.
Credit scores typically fluctuate a few points, so minor changes will not affect your rate or your eligibility for a loan. However, if you miss a payment during the mortgage loan process, this can cause your score to decrease upwards of 100 points (remember that payment history makes up 35% of your credit score)! Your credit sore can also be adversely affected if you take on additional loans, including credit cards and financing a new car, during the mortgage process. Do not be tempted by the discount at the register for opening store credit cards; save that for after your loan closes if you must!
If your score drops significantly your file will go back into the underwriting stage and it will be reviewed to see if you still meet the guidelines to qualify for that loan product. In some cases, if you no longer qualify and your lender has other programs to choose from, they can place you into a different loan product. So remember to be smart about the financial decisions you make and keep your loan officer in the loop to prevent being denied your loan.