If you are serious about purchasing a new home, knowing the ins and outs of your credit history is a must. It is easy to be distracted by looking at pictures of houses online and by attending open houses, but you need to take a step back. Before you even begin looking at potential homes, you need to get your financial ducks in a row. The first step is to obtain copies of your credit report and FICO credit score.
What is a Credit Report?
A credit report is a record of all your credit activity over your lifetime. The three big credit reporting agencies, Experian, TransUnion, and Equifax, create reports for those in the U.S. currently using credit. You are allowed to download a free credit report from these agencies once a year.
Your report often includes the following information:
- Personal information, such as current and former addresses, phone numbers, your social security number, and birth date.
- A listing of your current and past credit card accounts, including the credit limit, current balance, and payment history (including late or missed payments)
- A listing of any loans, mortgages, or other credit lines you may have
- A record of companies that have made inquiries on your credit report (e.g., when you apply for a credit card)
- Information on whether or not any accounts went to collection
- Public record information, which can include liens, bankruptcies, foreclosures, and overdue child support payments
Having a report from each of the major credit reporting agencies is essential. It is not unheard of for one agency to show a problem not listed on the other two reports.
What is a Credit Score?
If you manage your credit cards or banking online, you might be familiar with your three-digit credit score. These scores you see are meant for consumer use, while your mortgage lender will need to know your FICO® credit score. This is a number calculated using your past and present credit information and payment history provided by Experian, TransUnion, and Equifax. The score ranges from 300-850, and the higher your score, the better. The breakdown of your score looks something like this:
- 35% – Your Payment History – Overdue and missed payments, including medical and utility bills, can decrease your score
- 30% – How Much You Owe Creditors and the Amount of Credit Available to You – If you are using more than 20% of your available credit, it can decrease your score
- 15% – Length of Credit History – If you are someone who doesn’t use credit often, or is new to having credit accounts, it can lower your score
- 10% – Number of Accounts You Have / Number of Credit Report Inquiries – Having too many credit inquiries in a short time (e.g., applying for multiple credit cards) can look suspicious and lower your score
- 10% – Types of Credit You Use – Having a mortgage or a car loan that is well-maintained lets lenders know you can handle a large loan, while credit cards are a predictor of whether or not you will make payments in the future
Accessing your FICO® score usually involves a fee, although most lenders are willing to provide the information as part of their pre-approval process.
Why Is This Information Important?
Your FICO® credit score is a significant part of how lenders determine whether or not you are a risk. For example, there is a 1 in 8 chance that a person with a credit score of 600 will either be severely delinquent or in default of their loan. If a person has a credit score of 800, that chance is 1 in 1,300. So, the higher your score, the more likely you are to pay your loan on time and in full.
Knowing your credit score also puts you in a position to save money. Because people with lower FICO® scores are a bigger risk, they usually end up with a higher APR than those with a higher credit score. On a 30-year mortgage, that can be a difference of tens of thousands of dollars. Having the chance to fix problems means that you could save considerably over the lifetime of your loan.
It is a good idea to know this information before you start looking at homes because it can take four to six months to correct major credit issues. You don’t want to find the house of your dreams only to learn that bad credit will keep you from getting a mortgage. Instead, start the process prepared with a high score.
What Can I Do to Improve My Credit History?
If you have a low credit score, don’t panic. Instead, start to make a plan for how you will address any problems.
- Report Mistakes Immediately – If you notice credit cards or loans that are not yours, you may be a victim of identity theft. Contact the reporting agency to start getting these mistakes off of your credit report.
- Pay Bills on Time, Every Time – If you are prone to forgetting bills, now is the time to break bad habits. Use auto-pay or an app that keeps you on track for making those deadlines.
- Start Paying Down Debt – If you use too much credit or have your cards maxed out, start to pay down the balances. Once you get below the 20% mark, you should begin to see a change in your credit score.
- Don’t Take Out Any Credit – While improving your credit, don’t be tempted to sign up for another card or take out any loans. Those inquiries can lower your score just as you are trying to build it up.
Improving your credit score may seem impossible, but you can do it! With a little planning, a lot of work, and a commitment to improving your financial health, you will be in an excellent place for getting pre-approved for a mortgage.
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