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Do you dream of buying a new home? Maybe a vacation house at a favorite summer spot? You can make these dreams come true more easily, and more cost effectively, if you check your credit score before beginning your search for that perfect home. Both high and low credit scores can impact your home buying process—a high score may result in your approval for a larger mortgage, or save you thousands of dollars in interest. Conversely, a low credit score may make it difficult for you to secure financing for your home purchase, or result in a higher interest rate for your loan. In either case, it's important for you to know and understand your credit score.
The Purpose of a Credit Score
Created by the Fair Isaac Corporation, this three digit number reflects a great deal of information about you and your financial history. Your credit score is important to you, as a potential home buyer, because your score is one way lenders assess the likelihood that you will, or won't, pay your mortgage and other bills associated with owning a home.
Calculation of a Credit Score
There are three main credit bureaus in the United States which are responsible for gathering and tracking data about your credit cards, loans, and bills. These companies formulate your credit scores by assessing three aspects of a person's financial past: the payment history of bills; amount of credit available; and the usage of credit accounts. All three of these areas are assessed as a whole. So, although you may pay your bills on time, something else may negatively impact your final credit score. Scores range from 300 to 850—the median score is 723. Generally, individuals with a credit score of 760 or higher qualify for the most competitive interest rates.
Thirty-five percent of a credit score is based on bill payment history. The following are a few of the factors credit bureaus consider in making this assessment:
Items viewed unfavorably in determining your credit score can detrimentally impact the score for up to seven years! So, it's possible an account that was in collection, but has now been paid in full, will continue to impact your score long after it was resolved. While this lingering impact on your credit score decreases in importance over time, it's in your best interest to make prompt payments and avoid this situation. The longer you pay your bills on time, the better your credit score. If you do have past due bills, it's important you pay the balance and any penalties as soon as possible!
Amount of Credit Used
The dollar amount of credit used, or the amount owed, accounts for thirty percent of a credit score. When determining this amount, credit bureaus look at the following:
Individuals with the least amount of debt have the highest scores in this area. So, if you have many debts, the best way to boost this portion of your overall score is to pay down outstanding balances. Additionally, take care to avoid using the entire credit limit on your charge cards, close any unused accounts, and don't open new credit accounts.
The remaining thirty-five percent of a credit score is calculated by examining credit history—how credit is managed. In making this evaluation, the following factors are considered:
Credit accounts recently opened, and without a lot of payment history, can decrease the average age of all your accounts. Accounts that have been open longer have more history for the credit bureaus to assess - this helps to form a better picture of how you manage your debt. Because of this, especially when you're in the market for a new home, it's important you open as few new credit accounts as possible. If you've had credit issues in the past, now is the right time to begin to re-establish a credit history - open one account and make payments on time and for the full amount owed.
The Impact of a Credit Score
As you can see, a credit score is a reflection of a lot of information about you - this is precisely why the score is so important to a lender. It's a way to gauge the risk of making a loan to you. The lower your score, the higher risk you are. The more risk you pose to a lender, the higher the interest on your loan. Of course, the less risk you are, the lower the interest rate.
Your Credit Score
By now you're probably asking, what's my credit score? How can I get my score? A free report detailing your credit score is available to you once a year. It's a good idea to take advantage of this offering, even if you're not in the market for a new home—examining your report regularly will ensure that mistakes are corrected sooner rather than later and this will help you achieve, and maintain, a good credit score! To request a free credit report visit www.annualcreditreport.com, or call 1-877-322-8228. You can also contact one of the credit bureaus: Equifax, Experian, or TransUnion. If you've ordered and checked your credit reports for accuracy and simply want to see your current credit score, you can do that for a fee by contacting the Fair Isaac Corporation at www.myfico.com.
Updated: January 1, 2013
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
© 2013 Wilmington Trust Corporation.