Probably the most persuasive credential that you can present to a lender is an excellent credit score from all three reporting agencies. Most borrowers now understand that a good credit score is vital to their successfully securing a loan approval to buy a house. What is less well understood is that the best mortgage rates (the ones advertised or posted on websites) are only available to those with top credit scores. Those with lower scores, if they are able to get approved at all, will have to pay higher rates or more discount points. So it clearly pays to understand how to get the best score possible.
First, if you don’t mind, let’s review a few of the basics. A credit score is an estimate of your credit risk based on a snapshot of your credit report at a particular point in time. Credit scores are arrived at by inputting information about your credit history and behavior into a mathematical model. The scores typically used by mortgage lenders are based on the model developed by FICO (formerly Fair Isaac Co.) and are, thus, called FICO scores.
FICO scores range from 300 to 850 (the higher the score, the better). Scores above 740 typically qualify for the best rates. Lower scores are going to cost you, either by reducing your up-front discount points or raising your interest rate. A score below 600 to 620 will land you in very tenuous territory.
To see how different credit scores affect your mortgage rate, there is a loan savings calculator at myfico.com/myfico/Credit Central/LoanRates.aspx. While we have some quibbles about how accurate are the rate brackets shown, the calculator is pretty good illustrator of how poor credit scores do up the ante for riskier borrowers. Fannie Mae, for example, uses a matrix that hits borrowers who have lower credit scores with add-on fees called “loan-level price adjustments,” at 20 -point increments.
How is your score arrived at? According to FICO, your credit payment history is responsible for 35% of your score; amounts you owe, 30%; length of credit history, 15%; applications for new credit 10%; and types of credit used, 10%. You are entitled to a free credit report every 12 months from each of the agencies (you can request one online at annualcreditreport.com). but that doesn’t entitle you to a free credit score; for that you will have to pay.
Caution: be wary of web sites that offer you a free cred score, because it s not likely to be a FICO score, and thus, not what mortgage lenders will see. If you get a free credit report from one of the three main reporting agencies — Experian, Equifax and Transunion — they will be happy to sell you a score at the same time, but the scores may not be FICO scores either, so be aware.
Also be aware that if you are a co-signer on a student loan and the student is now unable to make payments, those non payments will be recorded on your credit records as well affecting your FICO score. It can be a very aggravating problem when you are trying to buy a house. First you have to get the loans current and then it take 90 or more days for the credit agencies to update their records.
Here are some tips for boosting and maintaining your credit score:
- Closing unused credit accounts won’t increase your score, in fact it may decrease it by having fewer open accounts. Don’t open new accounts just to increase your available credit; that could actually lower your score.
- If you are starting to establish credit, don’t open a lot of accounts all at once.
- Credit inquiries can lower your score. However, FICO scores distinguish between searching for a single loan among several lenders and applying for multiple credit lines. Try to fit your comparison shopping into a two-week period.
- If you are a co-signer on a student loan, monitor your credit reports every year. Know the status of the loan repayment.
Want more insight into FICO scoring? Check out myfico.com/CreditEducation/articles/, especially the PDF “Understanding your FICO Score.”