How Credit Scores Affect Loan Approval
A borrower’s credit status is a critical part of the mortgage process, and the quality of your credit report and scores can determine your ability to obtain a home loan. In fact, down payment requirements, loan programs, income flexibility and interest rates can all be positively impacted by a higher credit score.
Your credit score reflects your overall financial history and helps a lender establish your willingness and ability to pay. Following excellent money-management practices over time will improve credit and enhance your potential to secure an affordable home loan.
Credit scores are based on several key factors
Payment history: your payment history has one of the biggest impacts on your overall score. It is essential that you pay bills on time. Every late payment, collection, judgment, or bankruptcy significantly lowers your score.
Total amounts owed
Your available credit is compared to the total amount you owe. A good rule is to owe 40% or less of the total amount of credit extended.
Length of time the accounts have been open
Overall, the longer accounts are open, the more positive impact on a credit score. It may be best not to close a credit card you’ve held for several years, even if you maintain little activity on the account.
Type and mix of credit
Maintaining various types of credit (credit cards, installment loans, a home loan) can be beneficial to your score. In general, closed loans (such as a car loan that has been paid off) combined with active credit demonstrate that the borrower has experience managing money. However, too many open installment loans can negatively affect credit.
New credit and new credit inquiries
Some compensation is allowed for rate-shopping on home and car loans, but be aware that your credit score can be negatively impacted when multiple reports are pulled in a short amount of time.
Q: How can I establish credit when I’m just starting out?
A: Several factors can be used to establish credit, such as bank accounts, employment history, residence history and utility bills.
- Checking accounts are especially important for first time homebuyers and should be kept in good standing.
- A history of electric, telephone, cable and water utility bills paid on time can demonstrate to a lender the ability and willingness to pay.
- A secured bank credit card (linked to a deposit account) can help establish credit if kept in good standing.
- A department store credit card can also establish good credit history (be beware of the potential for high interest rates and pay off the balance in full every month).
Verify that these credit sources are being reported to the credit bureaus where possible.