Understand Your Credit and the Role it Plays in Getting a Loan

Your credit score is an indicator of your financial health and affects a lender’s decision to issue you a loan.

Your Credit Score Affects Your Home Loan

So you’ve finally decided to make the move and get the new house you need – or you’re starting to realize that your old place isn’t working for you anymore. Whatever stage you’re in, when you start thinking of mortgage, thoughts about credit follow up soon after.

Let us explain how credit works in the “world of mortgage.”

First, let’s talk about why. Mortgage lenders look at credit in order to determine if borrowers have a healthy record of paying back loans and if they usually do so on time. Credit reports and scores tell the lender about one’s debt and payment history on car loans, credit cards, consumer loans, and the like. To offer a loan, it makes sense to have some history, right?

Now, you may be wondering: what is a credit report and what makes up a credit score?

Think of it like this: Your credit report is like your financial report card and a credit score is a grade that’s given to your credit report.

FICO Credit Score Model

The FICO credit score is one of the most common score models used to determine the health of one’s credit. Scores can range from 300 – 850 and are compiled from the following categories:

  • Payment History (35%) – Do you typically make your payments on time?
  • Amount Owed (30%) – Do you owe a lot of money or are you using a high percentage of your available credit?
  • Length of Credit History (15%) – Do you have a history of handling credit?
  • Types of Credit (10%) – What type(s) of credit can you/have you handled?
  • New Credit (10%) – How recently and how often are you opening lines of credit?

This all boils down to one simple question: “Was the credit managed well?”

Tips to Manage Credit Responsibly

  • If you’re shopping around for the best rate and your credit gets pulled multiple times, it shouldn’t affect your credit score. As long as it’s done over a short period of time, usually 30 days, and it’s for the same type of loan (such as a home loan), it will be grouped together as one search. Just make sure to conduct your searches close together!
  • An inquiry on your credit by a lender tells other lenders that you are considering taking on a new debt, so be strategic about them. Apply for credit only when you need it and try to avoid applying for other types of loans or credit, such as a car or credit card, right before or during your mortgage process.
  • Review your credit records. Before applying for new credit, such as a mortgage, be sure your credit records are accurate. Each year, you can check your report for free at all three major credit companies: Equifax, Experian and TransUnion. If you’ve been denied credit, you can always get a free credit report (regardless of whether you’ve already received your free annual report). If any of your credit reports contain mistakes, contact the credit agency that compiled the report. For the link to the source of free reports, see the Resources section below.

Great Ways to Build Your Credit Score

  • Make payments on time, including mortgage, rent, credit cards and car loans.
  • Keep your spending to 30% of your limit on credit cards.
  • Pay off your debt instead of moving it around by paying debt with credit.
  • Keep your positive payment history – don’t close old accounts that demonstrate a good record of timely payments
  • Check for any errors on your credit report or anything holding down your credit score, and work toward fixing them (see above).
  • Work with a Mortgage Advisor or credit counselor to build your credit.

Omit Liabilities You Don’t Pay For

You can exclude a loan under your name or a liability you are a co-signer for, if someone else is actually making the payments. If, for example, someone else is paying for your car loan or mortgage, you may omit this liability, as long as you can prove it. There are a few conditions, though – there must be 12 months’ worth of payments made by this other person as well as no late payments.