Wednesday, March 15, 2017 / by David Connell
Are you about to take the first few steps to buying a new home? Maybe this is your first time purchasing Real Estate or it’s just been a while and you need a refresher? Throughout the course of the next few weeks we’ll go over the basic of buying a home, starting with understanding your credit score and how it affects your purchase power. Let’s get started.
What is a Credit Score?
Your Credit Score also known as a FICO score, is a reflection of your overall credit worthiness at the time of a given transaction. It is used by a variety of institutions; such as, auto loan lenders, credit card companies, cell phone providers, potential employers, and most importantly for our purposes, mortgage lenders.
2. What is your score composed of?
Your individual score consists of five categories.
· Credit Mix (10%): The different types of accounts you have open. IE, credit cards, installment loans, and Mortgages.
· Payment History (35%): This reflects how often you pay your bills on time, whether your late or always on time. It also makes up the largest chunk of your score.
· Total Debt (30%): Your debt to credit ratio, or the total amount of credit you have available versus the amount of credit you have used is reflected in this section of your score. This is the second largest factor used to determine your overall score.
· Credit History Length (15%): Our second to last section is the length, or ae, of your accounts. In this section your average age of accounts is calculated and applied to help determine your score. This can be one of the most confusing sections of your score. Note that although accounts do not need to be open to be included in calculating the age they do need to be on your report. The FICO scoring formula evaluates the ages of your oldest and newest accounts, along with the average age of all your accounts to get the results that are applied to you overall score.
· Credit Inquiries (10%): Last we have Credit Inquiries also known as a hard inquiry. These show up on your report each time you apply for new credit. Although it is one of the smallest factors it is advisable to limit the number of inquiries you have had as this can make it appear that you are desperate for credit and will lower your overall score.
3. Credit Score Ranges and Risk.
Credit scores range for a low of 500 to the highest score of 850. Where you land on this scale ca have a significant impact on your purchasing power and what sort of home you can finance. This is due to the fact that the lender considers an applicant with a lower score to be higher risk. If you find yourself in a lower credit score range this could affect your interest rates, home insurance costs or even your ability to get any financing at all. The different score categories are listed below ranging from high to low.
· 760-850: This is the highest band and is considered to be Excellent Credit. Being in this category can help insure you get the best rates possible when applying for a home loan.
· 700-759: Here we have the Great credit group. Although not as beneficial as having Excellent credit, you will still wield powerful purchasing power and be able to qualify for great interest rates when the time comes to buy a new home.
· 660-699: The mid to high 600s are considered to be in the Fair credit range. Most home loan programs will require you to score somewhere in this area. It’s important to remember that if you drop below this range you may not be able to qualify for some home loan programs and will begin taking significant hits on interest rates and some other costs.
· 620-659: Although still in the Fair category we are now approaching high risk credit applicants. If you fall into the range you will probably be at risk higher interest rates and may be disqualified for home loans.
· 500-619: Our last category is pretty broad. Here you’ll find the High Risk area of the total credit score range. Although you may not qualify for home loans in the category it important to remember that you can improve your score. To learn how raise your score into the Fair and higher regions continue reading section 4. Improving and Maintaining a healthy FICO score.
4. Improving your score and maintain good credit.
The steps to improving your overall score and then maintaining it once you’ve reached that magic number are easier than you may think. Let’s start by going over a few easy fixes.
· Subscribe to responsible repayment plans.
A. Pay your bills on time, this is going to be the most important step you can take. Remember that your score is 35% payment history, so this is your most important step in maintaining and repairing your score.
B. Bring any overdue or delinquent accounts up to snuff. You’ll need to make sure that any overdue accounts are made current as soon as possible. This will provide you with a significant boost to your total score. Remember that paying off a delinquent loan will not remove it from your score so be sure to contact the lender to ask if they can help provide proof showing the account has been paid off or made current
· Manage your Debt wisely.
A. Keep your debt to credit limit low. Generally speaking, the magic number is considered to be using 30% or less of your available credit at any one time. This will very between the three major credit reporting companies.
B. Pay off Debt rather than moving it between accounts. Here are many companies out there that advertise low interest rates on balance transfers. Although this can be a viable option it is always best to pay off the debt rather than move it to another account.
C. Don’t close unused accounts. Remember that your score is affected by the age of your accounts. So, if you have a few credit cards that have extremely low or no balances then keep them open. You never want to close an old account, this could significantly drop the average age of your accounts.
D. Don’t open unnecessary accounts. If you don’t need a new credit card or personal loan, then it’s always best to avoid opening a new account. The newer the account the lower your overall length of credit history.
· Be smart about shopping for credit.
A. Shop for new loans in a focused window of time. If you’re applying for credit from multiple companies, try to keep the applications close together. Though not always the case, doing this can cause the Hard Inquiries to show up as a single hit on your score versus multiple strikes spread out over a long period of time.
B. Re-Establish responsible credit use if you’ve had some trouble in the past. One of the ways this can be done is applying for a secured credit card, these cards have a balance that it determined by a cash value that you have put down with the company. Usually this will be in the form of a CD, certificate of deposit, that could be earning you interest while you rebuild your credit.
C. Check your Credit Scores often. By law the three major credit reporting agencies, Experian, Equifax and Transunion, have to provide you with a free copy of your report once every twelve months. Order online from annualcreditreport.com, the only authorized website for free credit reports, or call 1-877-322-8228.
D. Have credit-cards but use them responsibly. Don’t believe the myth that having a credit cards or other credit is bad, as long as you are using it responsibly this will help you build the credit history needed to secure a Mortgage.
· Lastly you need to be aware of a few things that can harm your credit.
A. Unpaid medical bills and parking tickets can hurt your credit score.
B. Heavy credit use can lower your score, even if you pay large balances off in full in a short time.
C. Your credit score will drop if you sign up and use store cards for initial discounts.
That’s it for Step One, hopefully you enjoyed this week’s article and found some good information. Comeback next week when we go over the next step in your home buying journey.
10160 Parkside Drive,
Knoxville TN, 37922