All of us dream of buying our own house someday. We want to own a house, have a family – a perfect picture! And to get to that perfect home of yours, there are requirements and processes which you can talk through with the experts at The Fejeran Group.
With all the things you should know when buying a home, let’s talk about how credit score affects the process of buying a house.
What is a credit score? The term credit score refers to a 3-digit number that represents a person’s creditworthiness. Most commonly, a credit score is the calculated score from a formula developed by Fair, Isaac, and Company or FICO – that’s why a credit score is sometimes called FICO score. They use credit information coming from the three major credit reporting agencies – Equifax, Experian, and TransUnion. This is the score most lenders and insurance companies today are using. Scores are calculated by FICO from the following components:
- Payment History – This determines the 35% of your credit score. Have you been paying your bills on time? The more bills consumer pay on time, the higher their score is.
- Amounts Owed – 30% of your score is determined by how many lines of credit you have, and how high the balance on each is.
- Length of Credit History – a longer credit history will increase your credit score. This is 15% of your total score.
- Credit Mix In Use – FICO considers the type of credit cards you have: retail accounts, installment loans, finance company accounts, and mortgage loans. This is 10% of your credit score.
- New Credit – The remaining 10% of your score is determined by how many credit accounts have you opened recently. Opening several credit accounts in a short period of time represents a greater risk especially for people who don’t have a long credit history.
With the use of credit score, people can get loans faster, helping lenders speed up loan approvals. Credit decisions are now fairer. Using credit scores, lenders can focus only on the facts related to credit risk and not on personal feelings. Negative credit information count for less. Your past credit problems fade as time passes and as good payment patterns start to show up on your credit report.
When it comes to buying a house, credit scores matter – BIG TIME! As the old saying goes…”Credit is King”… How? Your credit score is one of the factors that your mortgage lender will use to determine if you qualify for financing. Your score gives lenders a fast, objective measurement of your credit risk. You wouldn’t want it to below.
Your Credit Score When Buying a House
When you start the home buying process, the mortgage lender will check your application along with all the requirements before you are qualified to get a loan. Home buying qualifications include your job history, salary history, current wage, available credit, bill payment history, down payment and closing costs, ability to make monthly mortgage payments, and of course, your credit score.
Your credit score plays a big role in determining your mortgage loan interest rate. What are the types of mortgage loans? Fixed Rate Mortgage is one of the common mortgage loans where payments remain the same for the life of the loan – 15 to 30 years. Interest rates remain the same. Adjustable Rate Mortgage or ARM is another type of mortgage loan. ARM payment increases or decreases on a regular schedule with changes in interest rates. Another one is called Balloon Mortgage which offers very low rates for the first couple of years, around 5 to 10 years. After that, the balance is due or refinanced. Two-step Mortgage interest rate adjusts only once then remains the same for the life of the loan. For more information and other types of mortgage loans, call us at 972-948-0715.
Whichever among the mortgage loans mentioned above is used, the credit score will still affect the mortgage interest rate. The higher your score, the easier the buying process will be. If you have good credit, you’ll be given a mortgage loan with a lower interest rate. When I say good credit score, I mean a credit score of 700 or up.
So, does a bad credit score mean you will not be able to obtain a home loan? Luckily, no! So, don’t stop there. If you have a credit score of less than 700, it just means it’s not going to be easy but not impossible.
Let’s say you have a credit score of 695. That’s just 5 points less the 700 marks, but those 5 points can cost you thousands of dollars. For example, your loan principal amount is $200,000 with a 30-year fixed rate. That 5-point difference could result in paying $7,200 more in interest charges, assuming a 3.68% percent interest rate with a 700 credit score and a 3.86 percent rate on a 695 score. You could save that $7,200 for your downpayment if you increase your score for just 5 points.
The amount you need to put for the downpayment is also affected. The lower the credit score is, the higher the down payment will be. Someone with a credit score of 600, will end up putting down larger downpayment than somebody with a credit score of 700.
Don’t give up your dream home? Do you think that you may not be able to obtain a home mortgage? Even if you have bad credit, you can still get a home mortgage loan.
Remember, these are just examples. This is just to show how much the difference is between credit scores. The truth is, there is really no minimum credit score to get a mortgage loan. The problem is, every lender uses different methods and different factors to determine whether you have a good enough credit score or not.
There’s always a way when you want it. When you want to get better offers and get the right home for your family, work on your credit score.
The first step is to get a copy of your credit report. Check if there are items on your credit report that you think is disputable. Then, work on restoring your credit. Having a good credit score is a very important factor not only when buying a home…
Review and Improve Your Credit Score
You should take care of your credit because once negative information is recorded in your credit report, following the Federal Law, it will be removed after 7 years! While bankruptcy may remain on the record for 10 years. Include this information whenever you check your credit report. Under the Fair Credit Reporting Act, you have the right to have outdated information removed. If you notice that your credit report has negative information on it that is older than seven years, contact the credit reporting company and request that they remove this old negative information from your credit report.
Make time to check your credit report regularly. Examine the report closely to check for any possible discrepancies or errors. If you do find any discrepancies in financial amounts or any other errors, highlight them so that you can dispute them. If proven there were errors, the credit bureau is obligated to remove them. This is one of the easiest ways to improve your score.
After reviewing and resolving the discrepancies, your credit report will be adjusted. After all the adjustments, and it is not yet enough to bring up your score, then there are other things you can do to get a more desirable credit score.
It is best to start restoring your bad credit.
Be diligent in paying. Make sure all of your monthly bills are paid on time because late payments drive down your credit score. If you have missed payments, get current and be on time moving forward. You may want to set up Automatic Bill Pay using your debit card to avoid missing the due date of your bills. Having a record of “good payer” will grant you better scores.
Do not let any of your delinquent accounts go into collections. Try to pay them off. Your payment will be considered late payment. Better late than never. You also wouldn’t like outbound agents to be calling you every morning regarding your outstanding balance, do you? Consider debt payments in your monthly budget plan.
Avoid maxing out your credit accounts. Maxed-out credit accounts can also hurt your score. One tip is to transfer balances from a card that’s close to being maxed out to other cards to even out your usage. But it is best to pay it down. Sometimes, it’s just discipline. You know when your credit account is almost maxed out so don’t go on that 50% sale at the mall to avoid any unnecessary buys. Instead, remove a credit card from your wallet, hide it or cut it up and save for a substantial down payment.
BIG NO NO’s – There are also things that you shouldn’t do to improve your credit score:
- Don’t close unused credit cards as a short-term strategy to raise your scores. Closing unused credit accounts without paying down your balance may increase your utilization ratio. If you want to close credit accounts, choose the newer ones. Longer credit history will increase your credit score.
- Don’t open a number of new credit cards that you don’t need, just to increase your available credit. Opening several credit accounts in a short period of time represents a greater risk and this is 10% of your credit score.
In purchasing a house, it’s not just about the credit score. You can still purchase your own home even with a bad credit score. Yes, credit matters, but at the end of the day, the important thing to get approved is to let the lender know that you are ready, willing, and will be able to repay your loan.