e all have titles and roles that we've collected over our lives that help define us and how we go about our lives. Mother, brother, doctor, athlete, millennial, gay, tall, rich - the list is long of ways we categorize ourselves but there is one title that you carry throughout life that you may love or may hate and can greatly impact your home-buying process: your credit score. It's a mysterious figure that whether you pay attention to it or not, is always there. So what exactly is your credit score, how is it determined, and what role does it play when searching for your first home purchase/loan? That's exactly what we're breaking down in this installment on my tips from going from renter to owner.
According to the Consumer Financial Protection Bureau, a credit score "predicts how likely you are to pay back a loan on time." The score, which is a number ranging from 300-850, is found using a mathematical formula called a ‘scoring model' which uses factors and information from your credit report such as:
- Whether you make payments on time
- How you use your credit
- Length of your credit history
- Your new credit accounts
- Types of credit you use
Once you go to apply for a mortgage, one of the more common and sophisticated ways to determine one's credit score uses their FICO® Score, which helps lenders calculate interest rates and fees. 620 is the current minimum FICO® Score needed to secure a Conventional Loan, which is a loan that is between only the lender and the homebuyer and no government agency involved, but scores of 740 or higher would be considered excellent by most lenders. This type of loan tends to offer lower interest rates over more flexible repayment periods such as 15 or 30 year mortgage terms.
If your credit score isn't as high as you would like it to be, there are actions that you can take to improve it. The first piece of advice is to determine how much debt that you currently owe and do your best to pay off as much as you can because the less you are paying in old debts, the more you have to put toward new payments. Another big piece of advice is to do your best to pay your bills on time. This includes mortgages but also car payments, phone bills, home utilities, etc. And while it may seem like a way to up your score, you actually don't want to apply to more and more credit cards because that adds to something called a hard inquiry to your score which affects it negatively.
A lender will also take a look at your credit utilization ratio which shows how dependent you are on your credit cards. It's calculated by dividing what you typically charge on your card by your total credit limit and the lower this number is, the better. If you want to utilize your credit card(s) without driving up your credit utilization you can reach out to your card issuer about increasing your credit limit which they are more likely to do if you have a solid pattern of paying your bill. It's strongly advised not to close out credit card accounts because you lose that card's credit limit when your overall credit utilization is calculated, which can lead to a lower score.
Determining the exact credit score needed to earn the home loan you want is complicated and includes several factors unique to you and the property you're interested in. Find a great home loan expert who is trained in weighing out these factors early in your property searching process and if you need help finding one, be sure to check with your Realtor to see if they have trusted partners that they have recommended to clients before. While you are so much more than just a credit score, this number can be a huge hurdle to climb when buying a home so don't wait too long to take actions needed to get where you want to be.