With mortgage rates still near historic lows, many consumers are looking to purchase and finance homes, making it more crucial than ever for them to understand what part their credit score plays in the mortgage process. Here are some of the most commonly asked questions regarding credit scores and homebuying.
What Factors Affect My Credit Score?
The three credit agencies – Experian, Equifax and TransUnion – compile credit scores, also known as FICO scores, based on the information in your credit file, which is affected by these five credit factors:
- Payment history (35%) – Are you making payments on time? This is the most important component of your credit score.
- Amounts owed (30%) – How much do you owe on your credit accounts? Are you maxed out? Having a lower credit utilization ratio usually results in a higher FICO score.
- Length of credit history (15%) – Typically, a longer credit history will increase your credit score but it’s highly variable on the factors listed above.
- Types of credit in use (10%) – Do you have experience with both revolving credit (credit cards and retail accounts) and installment loans (car or student loans)?
- New credit (10%) – Research shows borrowers who open or apply for multiple credit accounts in a short time period tend to be riskier borrowers.
How Does a Lender Determine My Credit Score?
Your credit score is calculated by a combination of scores from the three previously mentioned national credit bureaus. Lenders, like Compass Mortgage, use your median score of the three, known as a FICO score. This scoring system is crucial to know, because if you often use a free online credit check, you are likely being shown only one of your three scores and could be misled to think your represented credit score is too low for mortgage qualification.
What If I Have Zero Credit History or a Low Score?
Sometimes potential homebuyers face a different type of issue with their credit score; instead of having a less-than-eligible score, they have too limited or zero credit history. Certain loan types allow borrowers to use what is called “non-traditional credit”. This allows borrowers to use account history from utility bills, phone bills and rent to build a credit history.
But what if you have credit history and your score is too low for qualification? There are several things you can do to build mortgage-ready credit.
First off, let’s say you meet with your mortgage banker for a pre-approval and your FICO score is just shy of the credit score requirement for a mortgage. Thanks to the process of “rapid rescoring”, you could potentially get approved for a mortgage. To do this, your lender can run a simulation to estimate how much your credit score could improve by taking certain actions, such as paying down a balance on a credit card.
After you, the borrower, have taken the actions suggested in regards to your credit score, your corrected or updated information is verified by your mortgage lender's credit reporting entity and then submitted to the credit bureaus.
This is when the "rapid" part of "rapid rescore" comes into play. With the new information, your credit report is updated within a few days and your lender can request an updated credit score.
If your lender doesn’t believe that rapid rescoring is an option for you as a borrower, there are other ways to build your score over time, including:
- Checking your credit report for errors
- Paying down high-balance cards
- Abstaining from opening new lines of credit
- Paying bills on time
What Credit Score Do I Need to Qualify?
Two thirds of Americans believe they need a “very good” credit score to buy a home, with 45% thinking a “good” credit score is over 780. In reality, a minimum credit score of 620 is required by all mortgage loans delivered to Fannie Mae, but individual establishments may have higher credit score requirements depending on the loan type and program. Currently, Compass Mortgage has the ability to finance FHA loans with credit scores as low as 560.
Your best option for determining how your credit score will impact your ability to borrow is to meet with a mortgage banker for a pre-approval. They will help you determine your best option for home financing, as well as help you develop a plant to increase your credit score if you don't currently qualify.
For more information about buying and financing your first home, download our free Mortgage 101 Handbook, a great resource for first-time homebuyers.