Have you ever wondered what determines your credit score? If you are in the market for a new home, you most likely have spent quite a bit of time analyzing that three-digit score and thinking about the best method to increase it. There are few numbers in your life that can wield so much power. Your credit score will not only determine whether or not you can qualify for a mortgage, but how much home you can afford, and at what rate your interest will accrue during the term of that mortgage.
The more you can know about where that number comes from, the better prepared you will be to get that number high before you decide to buy a home. Ideally, the more work you can do to improve your credit before meeting with a lender, the better off you will be. But if your credit needs some work and you are currently in the market for a new home, don’t worry. We will walk you through the process of understanding your credit score and what it takes to improve those numbers so you will be well on your way to home ownership in no time!
What is a credit score?
Your credit score is a number between 300 and 850 that reflects your activity based on an algorithm developed by the FICO Company. There are three major credit bureaus that act as databases for all of your financial history; Equifax, Experian, and Transunion. When you purchase something on credit, apply for a new line of credit, or make a payment on a credit card, that activity is reported to them and your score will fluctuate up or down depending on the algorithm. Positive changes will increase your score and negative changes can drop your score.
What will change my credit score?
There are five major categories that make up your credit history and in a sense, your score:
- Age of credit accounts – contributes 15% to total score
- Types of credit used – contributes 10% to total score
- Credit applications or inquiries – contributes 10% to total score
- Payment history – contributes 35% to total score
- Account balances – contributes 30% to total score
Since payment history and account balances have the biggest impact by far on your credit score, it is best to focus on these areas when trying to make improvements. For example, if you are trying to qualify for a mortgage but need to move up 20 points, focusing on paying off existing balances and making all payments on time will have the greatest impact. You should also refrain from open new lines of credit while going through the loan application process. Doing so will affect your balance-to-limit ratio and could help to maintain your score with little to no credit inquiries.
What is a “good” credit score?
There are loan programs out there for almost every type of home buyer with every credit score. But to ensure the best rates, you want to improve your score as much as you can. When it comes lenders or FICO definitions, you may fall into one of these ranges:
- Poor Credit: Under 630
- Average: 630 to 690
- Good Credit: 690 to 720
- Excellent Credit: Anything above 720
Don’t be alarmed if your score varies from agency to agency. There are small variations in the way that each bureau tabulates your information and sometimes each company might have differing information regarding your credit history.
You should request a copy of your full credit report from consumer.gov each year. A free copy can be obtained annually so that you can ensure you are aware of what is on the report and request errors to be removed.
With a little knowledge, you can demystify your credit score. While those three numbers will always have power over the purchases you will be able to make, knowing how it works will give you the power to change those numbers for the better.
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