Ready Your Credit Score for Homeownership
Ready Your Credit Score for Homeownership
President's Message
Chris Sloan
These days the news is abuzz with information about housing stimulus programs, low mortgage interest rates and real estate deals. But before you start bargain hunting, make sure to take a critical look at your credit score. In our post-subprime era, these scores play a significant role in determining who gets a mortgage and the best rates.
While there are steps you can take to quickly increase your score (e.g., making sure the information on your credit report is accurate), credit score improvement doesn't happen overnight. So if you're thinking about buying a home in the next few months, or even in the next year, now is the time to make sure your credit is in order.
Lenders use credit scores, which range from 300 to 850, as a measure of risk. The higher your credit score, the more likely you are to repay a loan. Although there are several types of credit scores, the most common is the FICO score created by the Fair Isaac Corporation.
FICO scores are calculated from the information contained in your credit report, which means you can have up to three FICO scores, one from each of the three major credit bureaus - Experian, TransUnion and Equifax - which can vary depending on the agency's information.
Because the scores are generated directly from the credit report information, you need to make sure each of your three reports contains accurate data. A U.S. Public Interest Research Group study discovered in 2004 that 23 percent of consumers had mistakes on their credit reports that were serious enough to result in a credit denial.
You can monitor your credit reports through the three major reporting bureaus and can obtain one free report every 12 months from each through the Web site www.AnnualCreditReport.com. If an error is found, you can request the error be corrected using either the www.AnnualCreditReport.com Web site or by writing a letter to all three bureaus. Patrick Richie, author of the book "The Credit Road Map," suggests including relevant documentation in the letter such as a canceled check showing payment. It is also a good idea to correct the problem at the source by contacting the creditor who reported the inaccurate information.
When reviewing your credit report, watch for accounts you don't recognize, inaccurate credit limits and erroneous account balances. Correcting errors can be one of the most immediate ways to raise your score.
Fair Isaac uses five categories to calculate a FICO score: payment history (35 percent), amounts owed (30 percent), length of credit history (15 percent), new credit (10 percent) and types of credit in use (10 percent).
Payment history is a record of whether you have paid your bills in the past. The score takes into account payments made on-time, late payments, and any bankruptcies or foreclosures. Even if you've had problems in the past, one of the most effective ways to raise your score in this category is by making on-time payments. Keep in mind, closing an old credit card account will not eliminate any late payments associated with it.
In the amounts owed category, the score looks at how much debt you have compared to your available credit. For example, if you're close to maxing out a credit card, that is associated with a higher credit risk and can lower your score. Fair Isaac suggests keeping your credit card balances low and paying down debt. Be careful when closing old accounts because that could interfere with your debt-to-available credit ratio.
Credit length is how long you've been managing credit. In general, the longer your history, the better your score. Fair Isaac warns those with short credit histories to avoid opening too many accounts too quickly, because it can lower your average account age, which can lower your score. Closing an unused credit card could also shorten your credit history.
The new credit section evaluates whether you're taking on too much new debt. Making multiple inquiries for credit and opening lots of new accounts can lower your score. To make sure shopping for a single mortgage or car loan isn't confused with a search for multiple lines of credit, Fair Isaac recommends limiting the process to 14 days.
Finally, the FICO score takes into account the types of debt you have. Having both revolving loans, like credit cards, and installment loans, like car loans, can help raise your score.
Of course, lenders will consider other factors when deciding whether to approve your mortgage application, such as your employment history and income. If you're concerned about your credit score, also keep in mind that mortgage programs like FHA are specifically tailored for those with less-than-perfect credit. For more information and tips on how to raise your score, visit www.MyFico.com.