Your Mortgage: Credit explained

Mike Miles

By Mike Miles

Credit scoring has the biggest impact on mortgage loan financing. It’s the main driver for determining an interest rate. It’s the best representation of the level of risk you present to a lender. Unfortunately, this three-digit number is confusing to many people when it comes to understanding how the score is generated.

The credit scoring model used for lending purposes is the FICO (Fair Isaac Corporation). Base FICO scores range from 300 to 850. Any score over 740 is considered A plus. Any score under 740 could start to see upward interest rate adjustments to accommodate for a higher risk rating. The lower the score, the higher the rate … in most cases.

So what components make up a credit score? Most people assume the score is based on making your payments on time. While that’s certainly true, it’s only a portion of how the number is calculated. Here is a graphic to illustrate what’s considered.

As you can see, paying your bills on time is the most weighted category but overall, it’s about a third of the entire puzzle. Here are some quick explanations of each:

Payment history:

This tracks your payments made on all accounts reporting on a credit report. If you pay on time, your score improves and if you are 30, 60, or 90+ days late … your score will decrease.

Amounts owed:

It’s okay to have balances on revolving accounts, but you want to keep them low compared to the credit limits. Maintaining a balance-to-limit ratio of 30 percent will increase your score. For example, if you have a $1,000 credit limit on a credit card, you should keep your balance below $300. The higher that ratio is … the lower your score.

Length of credit history:

Generally speaking, the longer you have an open account the better. This also measures the length of time between account usage, too. People think it’s smart to close accounts they don’t plan to use but that can hurt a score. That’s because it’s eliminating available credit and it’s shutting down an established account. Instead, keep accounts open and use them for small purchases periodically.

Credit mix in use:

The more diversity of accounts you have the better. This doesn’t mean to go get several credit accounts (auto loans, student loans, credit cards). It just means it’s good to have a balanced blend of installment and revolving accounts. That may or may not be possible depending on your situation. Some people have several student loans, which is okay. It’s not recommended to go get several credit cards to balance that out.

New credit:

Don’t open several accounts in a short period of time. This isn’t the same thing as having multiple inquiries. You can have a few inquiries in a short period of time if it’s for the same purpose and not resulting in a bunch of new accounts.

Credit scores can change quickly. They typically fall faster than they rise but if you practice the basics listed above, you’d be surprised at the pace of the rebound. It’s quicker than you’d think. Feel free to contact us to ask questions about your credit … especially if you are thinking of buying or refinancing a home within the next few months.