A Rocky Relationship: Credit Scores and Mortgages

A credit score tells a lot about you. It’s an important number that reveals financial information, derived from information found in your credit reports with Experian, Equifax and TransUnion. You’ve heard the saying, “you’re nothing but a number” as it pertains to an employer-employee work relationship, right? When it comes to applying for and getting approved for a mortgage, it may seem that you are nothing but your credit score! Your credit score indicates the amount of risk faced by credit card companies, personal loan lenders and car financing companies, when they loan you money. If you want to know what your credit score is prior to applying for a mortgage, the easiest thing for you to do is obtain a copy of your credit report from one of the major credit bureaus. A law was passed recently that allows every individual to obtain a copy of their credit report each year, at no cost, in an effort to help individuals find and correct errors to their credit reports. Having your credit report enables you to see what your potential mortgage lender will see in regards to your history of making repayments to your debt. Credit scores fall between the range of 300 and 900, with 900 being the best credit score and 300 being the lowest score. A person with a 300 score will have difficulty, if not find it impossible, to obtain additional financing for a mortgage or other purchase. An individual with a 900 credit score will not likely have any difficulties in obtaining a loan, credit card or other financing. How are credit scores determined? Credit scores are computed based on a somewhat secretive, somewhat difficult mathematical process! The largest factor in determining your credit score is based on your payment history. 35% of your score is derived from your history of making payments to your accounts. New lenders want to see that you make your payments on time and that you are paying the amount you are required to pay, as your past performance is a sure indicator for your future performance. You lose points to your overall credit score each time you make a late payment to a creditor that reports the late payment, when you file for bankruptcy or when you have accounts that get turned over to collection agencies to try to obtain the money from you on behalf of the creditor. About 30% of your actual credit score is calculated based on your current outstanding debt. All of your accounts are added together to determine the amount of money that you owe. Student loans, car loans, and credit cards, as well as any other loans, make up the total amount of debt that you are responsible to pay. If the amount you owe on your credit cards is over 25% of the amount you can actually borrow, you will have a lower credit score than a person who owes less than 25% of the total limit on their credit cards. Over the limit cards drastically impact your credit score. About 15% of your credit score is calculated based upon the length of time you have had credit. An individual with a credit history of 15 years will have a higher score than a 20 year old student who has just obtained their first credit card, even if the student has made every payment on time. Believe it or not, a full 10% of your credit score is actually based on how often your credit report has been looked at by potential lenders. Each time you apply for a loan or financing of some kind, the lender will do a credit inquiry to determine your credit worthiness. Excessive inquiries hurt your credit score as some lenders will see that as an indication that you are having financial difficulties and need to borrow money to stay afloat. Finally, about 10% of your score is determined by the types of credit you have. If your debt is mostly credit cards for example, you may have a lower credit score than someone who has a reasonable mix of credit- a car loan and two credit cards for example. The credit score is the first piece of information a mortgage company will use to determine whether or not they will take the risk to loan you money. The actual score you must have to qualify will vary from one mortgage lender to another, but if you have a score that is considered on the “low end” of the scale, you may want to do some work to repair your credit history before applying for a mortgage.