Your credit reports are an ongoing look at how you manage your finances. Lenders use your credit reports — and the credit scores they contain — when deciding whether to loan you money and how much to charge for your loan (interest).
Before you apply for a home mortgage, it’s a good idea to pull your credit reports to see if there are any surprises. Read on to learn more about why credit scores matter when you’re buying a home.
About Credit Scores
Your credit score is a number that is calculated based on your credit history to give lenders a simpler “lend/don’t lend” answer for people who are applying for credit or loans. This number helps the lender identify the level of risk they may be taking if they lend to someone. Although there are several scoring methods, the score most commonly used by lenders is known as a FICO because of its origins with Fair Isaac and Company. Fair Isaac is an independent company that came up with the scoring method and software used by banks and lenders, insurers and other businesses. Each of the three major credit bureaus (Experian, Equifax and TransUnion) worked with Fair Isaac in the early 1980’s to come up with the scoring method.
The number itself can range from 300 to 900. The following elements are considered when your score is determined:
- your payment history
- outstanding debt
- the length of time you’ve had credit
- the number of inquiries on your report
- the types of credit you currently have
Know your Score
Until recently, your credit score was not available to you. Now you can get your credit score at a number of Web sites, including the big three credit bureaus, and at Fair Isaac’s Web site. You can also ask your lender for access to your score when you apply for a loan.
Tips for Improving your Credit Score
Here are some things financial advisers say to do to try to improve your score:
- Pay your bills on time. (This is probably the most important of all!)
- Review your credit report and correct any errors you find. Getting rid of inaccurate (and bad) information can sometimes improve your score dramatically.
- Don’t close old credit card accounts just because you’re not using them. Creditors look at the debt-to-credit limit ratio so closing old accounts only raises that ratio – which you don’t want to do. Some people have moved debt from several credit cards to one card and then closed the old accounts. This can have a bad affect on your credit score because you have the same amount of debt but less available credit.
- Creditors also now look at the average age of your accounts so, again, keep those old accounts.
- Reduce your balances on credit cards to 75% or less of your available credit (25% is preferable).
- Don’t let anyone make an inquiry on your credit report unless you absolutely have to. The more inquiries, the lower your score.
- Don’t open new credit card accounts just to increase your available credit in the hopes of raising your score.
- If you go to the bank for a loan and are turned down because your score is too low, your would-be lender will get a list of reasons for that low score. You can use that list to try to turn your score around.
- Don’t be afraid of credit counseling. Make sure you contact a nonprofit agency such as Consumer Credit Counseling Services. They can help you set up a debt repayment plan. These services can negotiate lower interest rates and help you pay off your bills within a few years. Credit counseling probably won’t hurt your credit score. It used to, but about three years ago Fair Isaac discovered that people in debt-repayment plans were no more likely to default or go bankrupt than other consumers.
- Stay out of bankruptcy if you can. Bankruptcy is worse than delinquencies, loans or collections. Bankruptcy can knock 200 points, or more, off the score of someone with otherwise good credit. Mainstream lenders generally will reject consumers with a bankruptcy on their record — and bankruptcies are reported for up to 10 years.