First-Time Homebuyer’s Guide: Part 12
Understanding your credit scores
You’ve just made one of life’s smartest decisions: Applying for a home loan with the World’s First Digital Mortgage from Guaranteed Rate. One benefit of using the Digital Mortgage to secure your perfect home loan is the three credit scores that come with it, at no cost to you. But what do credit scores tell you about your situation? How are they created? Why are they different? To answer these questions and more, read on.
How is your credit score created?
Every time you pay off debt, you improve or maintain your credit score. Every time you make a late payment or incur unwanted attention from collection agencies, your credit score suffers. From utilities to medical bills to credit cards, every transaction or missed transaction that involves you and a creditor affects your credit score. Even the application for credit, before any funds or assurances are exchanged, can negatively affect it. After you submit a mortgage application, it’s very important to avoid doing anything that might have a harmful impact on your credit score. This includes making big purchases, applying for a credit card, and forgetting or neglecting your current bills, among other things.
What is FICO and “the three bureaus”?
You hear it and see it all the time: FICO score. It’s used so often that you might’ve never stopped to consider what it is or what it stands for. FICO originally stood for Fair, Isaac and Company, with the ‘and Company’ now ‘Corporation’. In 1958, engineer William Fair and mathematician Earl Isaac introduced a credit scoring system designed to predict the behavior of borrowers. The system eventually became the standard credit-reporting model for large lenders throughout the U.S., and is now used by the three major credit-reporting agencies, or bureaus: TransUnion, Experian and Equifax. To summarize, FICO is the system used to compile credit information, and the three bureaus are the data resources that lenders—including Freddie Mac and Fannie Mae—use to establish the creditworthiness of individual consumers.*
* According to FundingUniverse.com
Why are your credit scores different?
Ideally, the three scores from each bureau should be the same or very close to the same. The scores probably won’t be identical, however, and there are a number of possible explanations. First, each bureau may calculate your credit using slightly different methods. Second, some of your credit history may not be recorded by one or more bureaus. Creditors, courts and collection agencies all report to credit-rating agencies. Some consumers have a long and active credit history so the amount of information is significant, and certain data may slip through the cracks or fail to be reported in the first place. Third, lending institutions report to each bureau at separate times. Different credit scores may reflect nothing more than which agency has more up-to-date information. Finally, if you applied for credit under a different name—like a maiden name versus a married name, or Bill Smith versus William Smith—your scores may become fragmented or incomplete.
How can you improve your credit score?
Maintaining good credit is essential for securing a home loan because no lender will feel good about selling you a mortgage if there’s a chance you won’t pay it off. From the very first fiscal obligation you encounter in life—a phone bill, credit card, student loan—it’s important to make timely payments so that your credit score moves in only one direction: Up. Making late payments may not seem like a big deal, the assumption being that as long as the creditor gets its money, it’s happy. However, the credit reporting bureaus track every transaction, so whether you’re looking at a $35 department-store credit card bill or a $17,000 payment on the new yacht, making the payment after the due date will ding your credit score. As long as you pay off debt ahead of time or on time, your credit score should steadily increase.
What credit score should you aim for?
The FICO system is based on a score range of 300 to 850, with 300 the poorest and 850 the best score possible. Guaranteed Rate views any score above 740 as excellent credit. A credit score this high will make a powerful statement to lenders on your behalf, essentially telling them that as a borrower, you’re a sure thing. A score from 700-739 is viewed as good credit, and should put you in a good position to get a low rate on your home loan.
In next week’s First-Time Homebuyer’s Guide…
Part 13: Home loan pre-approval