Credit Score:
What It Is & How To Improve It
The home-buying process often begins with one number: your credit score. Those three digits play a major role in home financing. Let’s consider how credit scores are determined and the practical steps you can take to improve yours.
What is a credit score?
A credit score is a number that represents a person’s creditworthiness. It often plays a significant role in the mortgage approval process. Most commonly a FICO score, this number ranges from a low of 300 to a high of 850. The higher the credit score, the more confidence a mortgage professional will likely have in your ability to repay a home loan.
What’s a good credit score? While there are no official classifications, a typically “good” score falls in the 670 to 739 range. Above that, a “very good” score goes up to around 780, while an “excellent” score goes up to 850.
How do credit scores affect mortgage loans? Considered lower-risk borrowers, people with high credit scores may be able to negotiate more favorable terms, such as lower interest rates. A credit score can be a factor in determining loan type; conventional loans often require a minimum credit score of 620, while an FHA loan could get approved for a borrower with a score as low as 500.
What determines your credit score?
While several factors shape credit scores, none is more important than payment history. About 35% of a FICO score relies on your record of paying bills. Credit reports detail on-time, late, and missed payments on credit accounts, including credit cards and student loans. Mortgage professionals prefer a steady history of on-time payments.
About 30% of a credit score is based on your credit utilization ratio, which is the percentage of available credit you use. If, for example, you have a credit card with a $10,000 limit and you owe $5,000, that’s a 50% credit utilization ratio. When applying for a loan, you usually want a utilization ratio of 30% or below. If you’re nearly maxed out on credit card debt, a mortgage professional may see you as high-risk.
Length of credit history makes up about 15% of a credit score. A long, positive history can contribute to a higher score. Your credit mix makes up about 10% of your score. A diverse credit mix, with both revolving debt (e.g., credit cards) and installment debt (e.g., student loans), can positively impact a credit score.
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How do you check your credit score?
Checking your credit score is usually a critical first step in the home-buying process. And it’s a simple one.
Most banks and credit card companies offer free access to your FICO score. Several apps offer FICO scores, while others give you VantageScore credit scores, which are used less frequently by mortgage professionals. While FICO and VantageScore each use the 300 to 850 score range, they use different scoring models and shouldn’t be compared directly.
You can also get a detailed credit report. Each of the major credit reporting agencies (Equifax, Experian, and TransUnion) is obligated by law to give you one free credit report every twelve months. You can get your report, which does not include a FICO score, at AnnualCreditReport.com.
Checking your credit report is considered a “soft inquiry” that won’t impact your credit score. During the loan approval process, a mortgage professional will do a “hard inquiry,” which can temporarily lower a credit score from five to ten points.
What can negatively impact your credit score?
Here are some key factors:
- Late or Missed Payments: Failure to make on-time payments can be impactful and lasting; one late payment can stay on your credit report for up to seven years. In general, a 30-day late payment gets reported to credit bureaus, 60 days late has a moderate impact on credit score, while a delinquency over 90 days could lower a credit score by 100 points or more.
- High Credit Utilization Ratio: Maxing out your credit card or a credit line (such as HELOC) can significantly damage your credit score. If you’re borrowing up to 90% or higher of your available credit, that may cause your score to drop by 50 to 100 points or more.
- Collection Accounts: Debts that go to collection agencies can lower scores by 50 to 150 points and remain on credit reports for up to seven years. The impact depends on the amount owed, the recency (newer collections are more damaging), and the type (medical versus non-medical).
- Frequent Credit Applications: Applying for credit triggers a hard inquiry and multiple hard inquiries in a short time can signal you’re a high-risk borrower.
How can you improve your credit score before buying a home?
To improve your credit score before buying a home, start with these steps:
- Pay your bills on time. You can’t change past late payments, but making future on-time payments can steadily improve your score. Setting up reminders and automatic payments for at least the minimum payment can help.
- Pay down your credit cards. Aim to get your credit utilization ratio under 30%. Raising your credit limit to lower your utilization ratio could improve your credit score. However, the hard inquiry could slightly lower your score.
- Check credit reports for errors. They’re more common than you may think; recent Federal Trade Commission (FTC) data found that one in five Americans has at least one error on their report. You can dispute these errors and get them removed, which could improve your credit score.
- Become an authorized user. Do you have a family member or a close friend with impeccable credit? If they add you as an authorized user on a credit card with a positive payment history, your credit score could improve.
- Resolve collection accounts. Many collection agencies will settle debts for 30% to 60% of the balance. While these old debts stay on your credit report for up to seven years, paid collections are usually less damaging than unpaid ones.
You can’t improve your credit score overnight. It’s a process, however, that can begin today. If you want help along the way, call a member of the Equinox team at 1-888-505-8960 or connect with us online.