Does Credit Score Impact Home Buying?
Your credit score is one of the primary ways for a lender to determine your risk as a borrower. If you have a bad credit score, you are seen as a liability and will have to pay more to borrow money. This translates into higher interest rates and therefore higher monthly payments.There are quite a few ways to view your credit score and many banking apps will allow you to see your score. If your score is above 740, you don’t need to worry because that’s considered top tier and you’ll get the best rates.However, if your score is lower than 740, you’ll want to see if there are ways to raise it before buying a home. This process can take several months, so check your score well before you buy a home and stay up to date with it.Credit scores are made up by 5 various components, and each one affects your score differently.
The 5 components are:
Payment history - 35%
Amount of debt, also known as your credit utilization ratio - 30%
Age of credit accounts also referred to as credit history - 15%
Mix of credit accounts—10%
New credit inquiries—10%
PAYMENT HISTORY—35%
Your payment history is a track record of how good you are about paying your bills. Missed or late payments have a big impact on your score because someone who misses payments on one bill is more likely to miss payments on other bills. Make sure that you always pay your bills on time. If your credit report shows a missed payment somewhere, make sure you pay it off immediately.
CREDIT UTILIZATION RATIO—30%
Credit utilization ratio is a measure of how much of your available credit is used up. If you have a credit card with a $10,000 limit, but consistently have $9,000 on the card, that is a high credit utilization. The reason high utilization is risky is because you don’t have room to borrow more money. A good rule of thumb is to keep your credit utilization below 30%. So for that card with a $10,000 limit, never put more than $3,000 on it. If for some reason you do need to make a bigger purchase with your card, see if you can first raise your credit limit. Typically you can request an increase every 6 months.
CREDIT HISTORY—15%
Your credit history is the age of your accounts. If you have a long history of paying your bills on time every month, you’re more likely to continue doing so. This is one reason why it can take a while to get your credit score up. If you don’t have a long history of good credit, this section of your score won’t be as high. New credit accounts also affect this area. New credit lines are seen as a risk because a lender isn’t sure how you will use it or whether you will make consistent on-time payments.
MIX OF CREDIT ACCOUNTS—10%
Lenders like to see a good mix of credit types. For example, a credit card, a car payment, student loans, and a mortgage. While you should not seek to go into debt just to have a good credit score, having various kinds of credit accounts that are all in good standing shows you’re most likely a reliable borrower.
NEW CREDIT INQUIRIES—10%
Applying for new credit accounts is seen as a risk to a lender because it shows a level of uncertainty. Applying for car loans and credit cards can lower your credit score, especially if you already have a weaker score. Soft inquiries don’t have near the effect as hard inquiries. A soft inquiry is when you get pre-qualified for new credit, but a hard inquiry occurs when you actually open an account. Having your credit pulled to get pre-qualified for a mortgage loan will have little to no impact on your score.When you check your credit report, you should be able to find which areas are bringing your score down. If you make changes a few months before applying for your loan, you should have enough time to significantly raise your credit score.We love helping people improve their overall financial situation, so please reach out to us if you have any questions about your credit score or if you are curious about any other aspect of the home buying process. As always, make sure you also do your own research and talk to a lender about your specific financial situation!