If you’re in the market to buy a home, you probably already have a good idea what your credit score is. Like many prospective homeowners, you may even check it daily to see how and when it moves. But how much do you really know about the way your credit score is calculated – and how that magical number really impacts your mortgage approval when the time comes to apply?
Understanding what your credit score is, how it’s calculated, and its role in the mortgage approval process is essential for any aspiring homeowner. In this article, we’ll provide you with an overview of how your score is calculated, what you can do to improve it, and what it means for your homeownership journey.
What Is Your Credit Score?
Your credit score is a combination of several financial data points, totaling up to a three-digit number that typically ranges from 300 to 850. That number serves as a reflection of your creditworthiness – essentially, how risky of an investment you are – for lenders like banks, credit card companies, and insurance providers. The higher your number, the “safer” you are considered by these institutions.
Calculating Your Credit
Several factors contribute to your credit score, which can be broken down into five categories – each with a different level of impact on your overall score:
Payment History: Payment history makes up the biggest piece of the pie when calculating your credit score. Late or missed payments and public records of bankruptcy, foreclosure, or collections can negatively impact you. For most people, the single best thing you can do to keep your credit score in good shape is pay your bills, loans, and other debts on time.
Amount Owed: This is a calculation of how much debt you currently hold. Your total debt is added up and then used to determine your credit utilization – the percentage of credit being used from your total credit limit. Lower utilization is better for your credit score, so keeping a high credit card balance or holding large amounts of debt can negatively impact your score. Utilizing below 30% of your available credit is considered good practice for credit scoring purposes.
Length of Credit History: The longer you’ve been borrowing money (and paying it back) the better you look to lenders. The length of your credit history is calculated by adding up how long each of your loans or lines of credit have been open, along with a few additional factors that come into play with previous accounts that have been closed. For this reason, opening too many new accounts can cause your score to take a hit, while keeping older accounts open may sometimes be a good idea.
Types of Credit: Simply put, when it comes to credit, variety is a good thing. Having a mix of credit types, like credit cards, auto loans, and mortgages can indicate to lenders that you are capable of managing your finances and that you have experience handling debt.
New Credit: Opening multiple new credit accounts within a short period can be seen as risky behavior and may lower your score. After all, if someone has recently borrowed money, there’s a chance they may not pay it back – and in the case of credit cards, this could indicate a change in finances that requires borrowing more money. If you’re getting ready to apply for a mortgage approval, you should hold off on opening new lines of credit if it’s at all avoidable.
The Impact on Mortgage Pre-Qualification
Because lenders use your credit score to assess risk when evaluating your loan application, your score is a key factor in both getting your pre-qualification as well as determining the interest rate you’ll receive if and when approved. With a higher credit score, you’re more likely to get lower interest rates and qualify for larger loan amounts.
Furthermore, there are a variety of programs available to help homebuyers make their purchase process easier and more affordable, including several that are geared toward buyers with less-than-perfect credit scores. As always, if you’re looking for advice and guidance on your homebuying strategy, it can help to connect with an experienced loan officer to discuss options.
Wrapping Up
As you make your way along your homebuying journey, remember that your credit score is one of your most valuable assets. Knowing how your score is calculated and what you can do to improve it can help you set yourself up for success – so make sure you’re staying on top of it. With the right knowledge and planning, your score can be a powerful tool to help you achieve your homeownership goals!