For all the fuss about them, you'd think that credit scores would be longer than three digits. But that little number can make or break a mortgage application. Low scores can equal no house, or at least a hefty interest rate and down payment. Since credit scores are based on your credit reports, keeping your financial nose clean is the key to credit score success.
A credit score is a number that gives lenders, employers, and landlords a general idea of how you manage your money and credit. Mortgage lenders use credit scores to determine whether they should give you a loan as well as your loan terms: The better your credit score, the lower your interest rate. Contrary to what many think, there is no one credit score model and several companies sell their score-generating services to creditors and consumers alike. Most mortgage lenders use the FICO credit score, though some now use VantageScore, a new scoring system developed by the “big three” major credit bureaus.
Credit Score Factors
Information in your credit reports determines your credit scores. Different credit scoring systems may weigh certain factors differently, but score factors usually include the length of your credit history, how much of your available credit you currently use, whether you have recently requested new credit, and your history of paying your debts on time. Other factors include whether you have filed for bankruptcy, had a court judgment issued against you, or lost your home through foreclosure.
Other Lending Criteria
While mortgage lenders certainly place a high priority on credit scores in the lending process, your credit score alone does not determine your mortgage eligibility. Mortgage lenders also look at how much debt you have compared to your monthly income when deciding how much money to lend you. Most mortgage companies don't want to see your mortgage payment go over 28 percent of your monthly income, or your combined debt payments total any higher than 38 to 44 percent of your monthly income. Other concerns for mortgage companies include your recent credit history and, if you are a renter, whether you pay your rent on time.
Improving Your Credit Score
If you plan to buy a house anytime soon, hold off on applying for new credit accounts. Credit applications can ding your score for 12 months, and remain on your report for two years. Get your card balances down, but don't close those accounts. The more credit you have that you don't actually use, the better. Pull your credit reports from all three major credit bureaus and check them for errors. If you do this regularly, it is harder for identity thieves to mess up your credit, and you won't have any nasty surprises when you ask the bank for a loan.