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Did you know that increasing your credit score by 10-20 points before applying for a mortgage could save over $60,000 in interest payments in just the first ten years? Your three credit scores (each from a separate credit reporting agency) significantly affect what type of mortgage loan and interest rates you may obtain as a borrower. When determining your creditworthiness, most lenders pull your credit reports from all three credit reporting agencies (Equifax, Experian, and TransUnion) to view your accounts.
Your credit score is based on several factors, including:
- The timeliness of payments on your open accounts
- The amount of credit extended along with the remaining balance on your credit cards
- The length of time that a creditor has extended you credit (e.g., installment loans)
- The number of open credit accounts you have
- The number of inquiries to your report
- Any collection efforts or write-offs against any of your credit accounts
HOW IS CREDIT ESTABLISHED?
Starting your credit history isn’t as hard as it may appear, but you’ll want to be disciplined so you don’t damage your credit history or scores as you start out. Some ways to build your credit include:
Secured Credit Card
Usually through your local bank, an account is created, and a small amount (usually less than $1,000) is kept as collateral for the same amount made available for you to use in the form of a bonafide credit card. This allows you to use a credit card and make regular monthly payments while the bank limits the risk of not being paid back. It also helps you build your credit history.
Unsecured Credit Card
On the other hand, an unsecured credit card does not require a deposit to be held as collateral. The creditor may slowly increase the amount available to use as your credit history with them increases, and you can show consistent, on-time payments.
Merchant Card
These are usually department store cards such as Kohl’s, Target, Macy’s, etc., and are unsecured cards that can be used only for purchases in those department stores. Many furniture and appliance stores also offer credit for purchases in their stores through a 3rd party institution.
Car Loan
Whether through an automobile dealer or a bank, a car (or boat or motorcycle) loan will use the vehicle’s title as collateral in case you miss payments.
Bank Loan
Banks may also lend money for personal or business purposes, provided you meet their lending requirements. These loans may either be unsecured or secured with some type of collateral depending on the bank, the amount requested and other terms.
Authorized User
You could also become an authorized user on another person’s credit card with an existing good credit history. In some cases, a parent or responsible adult may allow you to become an authorized user on their credit card but opt to keep the extra card with your name on it in their possession so that it can’t be used. This effectively increases your credit score and improves your credit history even though you aren’t using the card because your name and social security number are equally tied to the account. Be careful, however, not to attach your name to someone else’s credit card account unless you are absolutely sure they pay their bills on time and will actually increase (rather than decrease) your credit score.
WHICH SCORE IS USED?
Because some creditors don’t always report borrower accounts to each of the three agencies, your three credit scores may differ from each other. Lenders usually will use the middle score of the three services’ reports to determine the credit score threshold for mortgage qualification. When there are two credit reports, lenders will use the average of the two scores.
Couples who apply for a home loan often have different incomes and credit scores. When evaluating borrowers for a joint mortgage, the lender knows more about the sum of the applicants’ scores, earnings, and debts. Typically, a lender will evaluate the application the way the applicants submit it, regardless of whose name is listed first.
WHERE DOES YOUR CREDIT SCORE PUT YOU?
Your credit score needs to be at or above a specific range to be eligible for certain types of loans. Consider the types of loans below and their minimum credit scores.
Conventional Mortgage: A credit score of 620 is generally the minimum threshold for qualification for a prime conventional mortgage. For every 20 points above 620, the interest rates drop. Borrowers with credit scores above 740 may qualify for even lower interest rates or even lower down payments. Lenders also like to see scores in the 700s for Jumbo loans.
FHA: The minimum credit score required for an FHA loan is typically 500, but borrowers with a credit score between 500 and 579 usually need to make larger down payments. Borrowers with a credit score of 580 or higher may qualify for lower down payments and lower interest rates.
VA loans have no minimum credit score requirement, but lenders may set their own requirements. As a result, borrowers with higher credit scores are typically eligible for lower interest rates.
USDA loans usually apply to borrowers with low-to-moderate income who want to buy in rural areas. The minimum credit score is typically 640, although some lenders may have different credit score requirements.
HOW CAN YOU INCREASE YOUR SCORE?
Here are some actions that might increase your credit score before applying for your mortgage loan.
- Pay off debt. But be careful… you may actually worsen your credit score by paying off debt too quickly. Generally speaking, your credit score is more favorable when the open credit account or installment loan being paid off is at least one year old. Above all, pay it off on time!
- Obtain a free credit report and dispute any incorrect information.
- Reduce the percentage of your credit card usage by paying balances down and requesting an increased credit limit on them.
For more information, read how to quickly improve your credit score from NerdWallet.
Your credit score is just one of several factors that lenders consider when evaluating your mortgage application. They may also consider employment history, income, debt-to-income ratio, and other financial information. For a recommendation of excellent, knowledgeable mortgage specialists who will assist you in understanding the specific requirements for the best mortgage product for you, contact me today!