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The days of easy mortgage money for everyone are over for a while at least. Lenders are raising credit standards, making it more difficult to get the best deal if your credit isn't squeaky clean. So it is more important than ever to make sure your credit scores are as strong as possible so you can get a good loan, whether you are looking for your first home loan, or hope to refinance your current mortgage.
When it comes to home loans, credit reports and scores are used to help:
- Determine with loan program you qualify for,
- Determine the interest rate you'll pay,
- Set your rate you will pay for Private Mortgage Insurance (PMI) if it is needed on a low down payment loan,
- Determine what discounts you will qualify for on homeowner's insurance.
Lenders use three-bureau residential mortgage credit reports (often referred to in the industry as a "tri-merge"). These reports are provided sold only to lenders and loan officers by specialized credit reporting companies that access your credit information from all three major agencies - Experian, Equifax and TransUnion - and compile them into a single report.
If you are married, understand that while you each have your own separate files with the credit bureaus, the mortgage credit reporting agencies can compile a report that includes information on both spouses. But each of you will still have your own separate credit score from each agency. In most cases, the spouse with the strongest income will be the primary borrower on the loan, and the other spouse will be the secondary borrower. If one of you makes enough money to qualify for the loan by yourself, then your spouse does not have to be on the loan.
Along with this tri-merge credit report, the lender will purchase your credit score from each of the three credit reporting agencies. The score most often used is a Classic FICO® score. Classic FICO scores can be as high as 850 points (though few consumers have a perfect score) and as low as 300 points. These three-bureau FICO scores are not the same as other credit scores provided to consumers through credit report subscription products. The only place you can obtain all of them directly as a consumer is at MyFICO.com.
Most lenders are going to look at your FICO score from each of the three credit agencies, then use the middle of the three to determine which program you qualify for (interest-only, or no income documentation required, for example), as well as your interest rate. The score isn't the only factor that's important: income, debt and employment also matter. But strong scores are valuable so here are some tips for boosting yours.
Start Early: Mistakes on credit reports can take weeks (if not months) to fix, even when the lender or credit reporting agencies acknowledge the error. Review your credit reports and scores early in the process, to give yourself time to fix mistakes and make improvements. If you need to correct a mistake on your credit report quickly, you may want to ask your loan officer about a service called "Rapid Rescoring."
Get Good Advice: There is no shortage of advice about how to improve your credit scores, but it is not always accurate. Be especially wary of "quick fixes" that may hurt your score, rather than help it. Experienced loan officers may even give wrong advice. Credit scoring formulas change periodically, and if they are not on top of those chances they may steer clients in the wrong direction.
Don't Guess: You may hear that you can boost your credit score by removing an inquiry (7 points), or by adding a new credit card (9 points). This is not true. Credit scores are just not that simplistic. These formulas take into account everything in one's credit report, and a particular action may have a positive effect on one person's score, a negative effect on another, and do nothing for another's!
A tool such as a credit score simulator can help you better understand how different actions may affect your credit score, however. Score simulators allow you to see the effect particular actions, such as paying down a credit card balance, may have on your score. Simulators may be available through your loan officer, through the credit reporting agency they use to access mortgage credit reports. You can also use a simulator available through MyFICO.
What May Not Help Your Score
Closing Old Accounts: Leave old accounts alone! Closing old credit cards you don't use anymore is more likely to hurt your credit than to help it. A longer credit history can benefit you, and as far as the FICO score is concerned having a lot of available credit it not in and of itself damaging to your credit.
Paying Collection Accounts: Whether it is paid or not paid, a collection account is negative on your credit, and paying it can actually drop your score in some instances. Unless the lender requires you pay off a collection account to get your loan, or you may be sued, you may want to hold off paying the account until your loan closes.
Boosting Income: Your income does not affect your credit score though a larger documented income can help your loan application in other ways, such as allowing you to qualify for a larger home.
What May Help Your Score
Paying Down Credit Card Balances: Ideally, try to keep your revolving balances lower than 10 -- 30% of the available credit on a given account. (Revolving accounts include credit cards, and some lines of credit.) A few major credit card issuers do not report credit limits and when that happens, even a small balance can make you appear "maxxed out." Try to pay those accounts down, but don't close them.
Using Credit: Some consumers who have been through credit difficulties like bankruptcy shy away from using credit cards. But for the sake of your credit score, you need to continue to use credit. One or two major credit cards paid on time can be beneficial to your scores, and many mortgage lenders want to see four accounts open, active and paid on time for at least 12 - 24 months. Note that for mortgage purposes, an account often must be open for at least twelve months to be counted as active, so getting new credit cards or loans is not a quick fix and may hurt you.
Shopping Carefully For a Mortgage: When someone checks your credit report, it creates and inquiry and numerous inquiries into your credit file can affect your credit score. There is a special buffer built into the FICO score to allow consumers to shop for best deals: All mortgage and auto-related inquiries within the most recent 30-day period are ignored, while mortgage-related inquiries or auto-related inquiries within a 14-day period (before the most recent 30-day period) are treated as a single inquiry. Still, some inquiries may get around this buffer and lower your score.
Tip: Checking your credit report directly through MyFICO does not affect your score.
Final Warning:
Do not make any major changes to your credit situation until your mortgage closes, such as opening a new account to buy furniture or appliances for the new house you are planning on buying. The lender may pull a new credit report prior to closing and the new account could sink your credit score!
Gerri Detweiler has been helping consumers find answers to their credit questions for more than twenty years. She is the author of four personal finance books including The Ultimate Credit Handbook. She helped launch FreeRateSearch.com, the first mortgage search engine that allows consumers to compare mortgage rates using technology previously only available to loan officers. She welcomes consumer questions about mortgages on the FreeRateSearch.com blog. You can read her article about Rapid Rescoring here.
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