A credit score is part of each home buyer’s whole debt and income picture. Lenders consider it a key factor when deciding to approve a loan application. To put the score in context, a lender’s top questions are:
- Whether the borrower can repay the loan, and
- Whether past credit history suggests that the borrower will repay the loan.
The FICO® Score, which is the best known of several credit scoring tools, comes from the Fair Isaac Corp. As we’ll see, mortgage lenders can take other scores into account, too, and even tweak the factors in the scores to come up with unique tests for loan approvals. The good news? While mortgage lenders use their secret sauces to determine creditworthiness, we, the applicants, give them the ingredients.
Here, we take a look at how credit scoring actually works, and how to optimize your score.
How to Get the Credit Score You Need for a Mortgage Loan
Although several current Fair Isaac scoring methods go up to 900 points, the usual scale goes from 300 to 850, and applicants need scores of at least 620 for a conventional mortgage approval. (This is considered a “fair” score by the leading credit reporting companies.) People who score about 750 and up are most likely to get the widest selection, the best loan terms, and the lowest available interest rates.
So, how does a borrower get there? What makes the FICO® Score tick? We do! Sometimes we use credit more, sometimes less. Naturally, everybody’s credit profile has its ups and downs from quarter to quarter, and that’s no cause for alarm. But paying off loans and credit card bills on time (or almost always on time) and keeping balances relatively low (relative to the limit on a line of credit) are solid factors in achieving a better score. Both the credit scoring companies and potential lenders put more weight on your recent credit activity — the last two years count the most.
What else counts?
- How long your accounts have been open. Longevity is good.
- Whether you hold diverse types of credit, such as a mortgage as well as credit card accounts and installment payments. Diversity is good.
On the other hand, what can hold a score down?
- Overdue credit accounts and accounts in collections. If you are reported as 30+ days late with your payment, your score will probably dip.
- Recent credit card applications. An inquiry on your credit can weigh on your score for several months, so open new credit accounts wisely.
You’ll need to contend with a few wild cards, too. Different industries size up your credit using different scores. Credit card companies often rely on FICO® Score 8, whereas the earlier versions — FICO 2, 4, and 5 — prevail in the mortgage industry. So, the FICO score on your bank account website might be better than the score your mortgage specialist says you have. To complicate the matter further, lenders can customize their models to prioritize specific factors in your credit profile. Lenders can also decide what additional financial data goes into their approval decisions.
Pro tip: Because you might think your score is higher than what your mortgage lender actually uses, it’s good to be a little higher than you need to be.
Why So Many Different Credit Scores?
Various algorithms come into play for different scoring occasions: getting an auto loan, opening a new credit card account, applying for a mortgage. Industry professionals receive fine-tuned credit assessments to predict the customer’s likely future activity in the kind of account they’re currently applying for.
The various scoring models are all updated from time to time, with new versions and new capabilities. FICO® Score 8 goes easier on isolated late payments than earlier versions. The newer FICO 9 model is of interest to people with limited loan histories, because it factors in rental payments if the landlord reports them. Here’s why new scoring methods keep coming out, in Fair Isaac’s own words:
Think of how people use different versions of computer operating systems or have older or newer generations of smart phones. They all share the same base functionality, but the latest versions also have unique updated features to meet evolving user needs.
Plus, Fair Isaac is now competing with other scoring products. An important one is the VantageScore, created jointly in 2006 by the three major U.S. reporting agencies: Experian, Equifax, and TransUnion.
Mortgage lenders may use the VantageScore by itself, or in combination with FICO. VantageScore identifies itself as a corporate leader in applying rent, phone, and utility data to be more inclusive of applicants, and to offer lenders “a more complete and fairer picture of their customers’ creditworthiness.”
No matter which score, which version, or what kind of blend of credit scores may be applied to your application, a few simple actions can and will boost your profile. Read on to see if you’re on track.
☛ Getting Ready to Make Your First Home Purchase? Don’t Miss our Tips for First-Time Home Buyers.
Boost Your Credit Profile During the Mortgage Approval Process
If you have already set sail in your home buying voyage, and your score needs attention — or if you simply need to avoid slip-ups during the adventure — you can take effective action. Small score boosts can mean big savings over the course of a mortgage, as shown by the FICO Loan Savings Calculator, and even as you navigate your mortgage approval process, nudging your score up can help your loan come out with a lower interest rate. Here are just a few examples of actions you can take:
- Ask your mortgage expert whether you should apply for a new line of credit during this process to diversify your profile. It might be worth the effect of a hard inquiry on your report. Your mortgage specialist can tell you which kind of credit application to submit. For example, an internationally accepted credit card would have a stronger positive impact than a local store card.
- Don’t close any credit card accounts at this time. It can negatively affect your credit utilization rate.
- On-time payments through this time are absolutely critical. Visiting your credit cards’ websites and setting cards to automatic payment mode is another simple move you can make to support a good score.
- Also, download your annual credit report. Be sure your details are reported right. Find out if any errors are being held against you, and catch possible signs of identity theft.
- If you find late notices on your credit report, submit a request for a goodwill adjustment to the company. If you’re a good customer and the late notices don’t reflect your recent performance, the company might agree to delete the notices, improving your profile.
Throughout this time, keep assessing your credit use. You need to present yourself to a potential lender as more of a saver than a spender. Ideally, this means keeping your spending well under 30% of your credit lines — lower is better.
Building Credit Is Just a Part of a Healthy Financial Profile.
The world of credit is changing, especially as lenders have reacted to a public health emergency. They’ve had to readjust their view of risk and their expectations of borrowers.
Having a reliable income is an increasingly critical part of the picture. An excellent credit score will certainly bring you better loan terms, but if you can show steady and dependable income, or if you are able to put at least 20% down, you should be able to achieve your home purchase goal, even with a fair credit score.
Once you’re in the new home, there’s more good news. You’ll build your credit higher as you faithfully repay that mortgage.
Photo credit: Katie Harp, via Unsplash.