You are thinking about buying a new home. For kicks, you search online to see what’s available. There isn’t much to choose from, but you search again every few days just in case something new pops up. When you’re least expecting it, you find a house that could work for you. After thinking it over, you call the real estate agent to ask if you can see the house. In turn, the agent asks if you are pre-qualified. You aren’t. You haven’t even thought that far ahead; you just want to see the house! The agent insists you talk to a lender and get pre-qualified before booking a showing (i.e., an appointment to view the home). You talk to the lender the agent recommends and they want to run a credit check. Will your credit qualify you for a mortgage?
Whether you are in the market to buy a home now or you plan to buy within the next few years, maintaining good credit is an essential long-term strategy for buying your home. What you do today affects not only your eligibility for a mortgage tomorrow but also your interest rate.
How Credit Scores Are Determined
Credit scores are based on five different criteria:
- Payment History. 35% of your credit score is based on whether or not you pay your bills on time, if you have any collection accounts, and/or if you have any public records (i.e., tax liens, judgments, bankruptcies, lawsuits, foreclosures, etc.).
- The Number of Open Tradelines. 30% of your credit score is based on how many accounts (i.e., tradelines) you have open with an outstanding balance.
- Credit History. 15% of your credit score depends on how long you have maintained credit. The longer you have been using credit, the better. Also, the longer a tradeline has been opened, the better.
- Credit Inquiries and New Tradelines. 10% of your credit score is dependent on credit inquiries and new accounts you have opened. While it is good to establish credit, your scores will suffer if you apply for a lot of new debt in a short amount of time. Mortgage lenders consider the number of credit inquiries in the past 90 days, and they will check again before loan closing to make sure no new inquiries have occurred during loan processing.
- Types of Credit*. The last 10% of your credit score is determined by the types of credit accounts you have open. (e.g., installment loans, revolving credit card debt, and so on)
*Credit guidelines among different mortgage types (e.g., conventional, FHA, VA, USDA) vary. In a very general sense, mortgage lenders will want to see two (2) to three (3) tradelines that have been open for 12 to 24 months with payments made on time. For example, a loan applicant who has been making a rent payment on time for the past 12 to 24 months, has made auto loan payments on time for the past 12 to 24 months, and keeps a credit card at or below 30% of its credit limit with all payments made on time within the past 12 to 24 months may be a strong candidate for mortgage financing. There are exceptions to this, and more is involved than qualifying based on credit alone, so ask your lender if you qualify for mortgage financing.
Which credit score do mortgage companies use?
There are three different credit reporting agencies:
When applying for a mortgage, your lender will pull a report from all three agencies (i.e., a tri-merge credit report). Scores range from 300 to 850. Mortgage lenders use the middle of your three credit scores for loan qualification. If you only have two credit scores, your lender will use the lesser of the two scores.
What you may not realize is that there are dozens of different scoring models. Mortgage lenders use FICO® scores to qualify you for a new mortgage, but even then there are different FICO® scoring models. Most mortgage lenders use FICO® Score 2 (i.e., Experian), FICO® Score 5 (i.e., Equifax), and FICO® Score 4 (i.e., TransUnion). There are newer FICO® scoring models available that the mortgage industry may soon adopt, so this is subject to change.
This rating system is a little subjective, but gives you an idea on how lenders evaluate credit:
Credit Score Rating
800 – 850 Excellent
720 – 799 Very Good
640 – 719 Good
580 – 639 Fair
579 or below Poor
The minimum credit score required for mortgage financing varies from lender to lender and loan program to loan program.
How To Improve Your Credit?
There are several things you can do to improve your credit.
One of the first things you should do is get a copy of your credit report. You can request a copy of your credit report from all three credit reporting agencies for free once every year through www.annualcreditreport.com. This is the only Federally-approved method of pulling your credit report for free each year. Many other companies claim to provide access to your credit, but charge you fees for various credit-related services such as credit monitoring or credit repair. Beware of imposters and gimmicks!
Dispute any inaccuracies you see on your credit report with Experian, Equifax, and/or TransUnion. If you have attempted to dispute an inaccuracy but are having troubles with any of the credit reporting agencies, you can submit a complaint to the Consumer Financial Protection Bureau (CFPB), FTC, or Fair Isaacs.
Make all of your payments on time.
Pay down your revolving debt to 30% of its limit or less. For example, if you have a credit card with a limit of $1,000, pay down the balance on the card to $300 or less. This one step may increase your credit scores significantly!
Pay off collection accounts.
Reduce the number of open tradelines you have. It’s awfully tempting to take advantage of that 10% off offer from your local retail store when you go to check-out but beware of the consequences to your credit score!
Credit Scores and Interest Rates
Qualifying for a mortgage is only half the battle. Your credit plays an even larger role: determining your interest rate. The higher your credit score, the lower your interest rate.
Taking good care of your credit can not only help you qualify to buy a new home, but also help your dollar stretch a little further. If your interest rate is higher, you will qualify for less. If your interest rate is lower, you will qualify for more. Even if you don’t want to spend more on your new home, having the benefit of a higher credit score will lower the monthly payment on your new mortgage.
Whether you are in the market to buy a home now or don’t plan to buy one for a few more years, improving your credit now will pay off dividends later when you are ready to make your move.
When the time is right, it is best to have a pre-qualification letter in hand before you begin your new home search, so you book showings and place an offer quickly.
Jennifer Goldsby, NMLS #591226 | VP, Renovation Lending
Diamond Residential Mortgage Corporation NMLS #186805 | Equal Housing Opportunity
Disclaimer: The postings here reflect my personal opinion. They do not necessarily represent the opinions of Diamond Residential Mortgage Corporation and its management.
