Shopping for a home requires planning and budgeting to find a place that is both pleasing and affordable. While budgets, desired lot sizes, and neighborhoods may differ dramatically, depending on the homebuyer, one thing is consistent: if you need to secure a mortgage loan, you need to consider your credit score.
Some buyers may have had time to learn about credit scores and have managed their credit score wisely over the years. Often, however, there is misinformation about how credit scores are formulated or what they predict. If you are shopping for a home, here are eight points you should know about your credit score.
To understand what actions will help your credit in your own specific situation, speak with your lender or a financial advisor.
1. There are Actually 3 Credit Bureaus
There are three major credit bureaus, Transunion, Experian, and Equifax, who offer up credit scores. They actually compete with each other and don't share information with each other. While each of them use similar formulation models, there are small differences. In addition, certain creditors may only report to one or two of the bureaus, so all of them may not be privy to the exact same information. These factors may cause a person's credit scores to vary quite a bit.
Keep in mind that many lenders will judge your credit worthiness by your average score. So, should you check your credit scores online, remember...
2. ....Mortgage Credit Scores Are Different
To make it more complex, each type of credit score has a unique formulation. There are credit scores geared toward general consumer reports, auto loans, credit cards, insurance, and, of course, mortgage loans. If a person pulls their own credit information and score online, they generally receive a consumer generated report. The credit score on this type of of report can vary tremendously in comparison to a report pulled by the lender.
Homebuyers who are trying to secure a mortgage loan should try to get pre-approved and check their credit as early in the process as possible. This way, you will know your mortgage credit score up front and not be unpleasantly surprised after spending time finding a home.
3. You May Not Have a Credit Score
According to a 2015 study by the Consumer Financial Protection Bureau (CFPB), 26 million Americans are "credit invisible" - meaning, they do not have enough in their credit file to generate a score.
Not having a credit score usually affects your mortgage options negatively, but not having a credit may not exclude you from buying a home. There are some loans that work with non-traditional credit types, such as rent payments, utilities, cable, etc, that can service you if you are in this segment of the population. However, it's usually easier to secure a mortgage loan if you build and maintain a credit history, than not having one at all.
4. Debt Can Derail Your Efforts
Credit cards managed wisely help build credit scores. Maxing them out may have the opposite effect.
The credit scoring models of the credit rating agencies examine the ratio of your debt compared to the limit. For example, if your credit card has a $5000 limit, and a $4000 balance, your ratio is 80%. Credit scoring models usually generate higher scores if the ratio is 30% or under. If your credit cards are all close to being maxed out, that may begin to significantly lower your credit score.
5. You may Qualify for a Mortgage With a Lower Credit Score Than you Think
You may think that you need to have a high credit score to qualify for a mortgage loan. However, this is not the case. There are loan programs that you can qualify potential home buyers for a mortgage with medium to lower credit scores. So, if you have made past credit mistakes, you may still be able to qualify for that loan and get the home you want.
6. Old Collections are Less Important Than Current Ones
Frequently there are buyers who decide to clean up their credit by paying off old collection accounts. This may not always be the best idea for every situation. Collections are viewed by date of last activity. Often, an old collection that has been on your credit for a few years may not be affecting the credit score much. But, by paying the old collection, the action of current payment actually moves the date of last activity up to the present, as if it just happened.
This may have negative effects on a credit score. Many home buyers, after discussions with their financial advisor or mortgage broker, may decide to leave them alone and pay them at a later date. This way it doesn't affect your credit score during your home buying process.
7. Co-signing may Harm Your Credit Score
Being a nice friend or relative by co-signing a loan can set you up for disaster. By definition, a co-signer is responsible for the debt, just like the main debtor, and, if they pay late or not at all, it shows up on your credit report as well.
Financial advisors often suggest to not co-sign a loan if you are considering a home purchase soon. However, if you have already co-signed on a loan, make certain you check your credit every few months to see if the debt is being paid.
8. Divorce Decrees Don't Supersede Creditors
Couples who part ways may divide up debts during the divorce proceedings. It's important to remember that the original debtor contract is, in most cases, still binding. This means if your ex-spouse was supposed to pay your joint VISA bill and didn't, this debt will show up on your credit report, and may hurt your chances to secure a mortgage loan.
During a divorce, diligently work to get every debt that is handled by the other party taken out of your name. Common moves are re-financing, opening new credit cards and transferring the old balances, or paying the debts off.
Shopping for a home, whether for the first or tenth time, is exciting. Stay educated and informed about the process, and take measures to protect and build your mortgage credit score so you enjoy a wide array of mortgage loan options.