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Your 2022 Handbook to Understanding Credit Scores

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What You Need to Know About Managing Your Credit Score for Homebuying Success

When getting ready to purchase your first home, setting your credit score up for success is the best thing you can do…and it’s much easier than you may think. It starts with understanding what makes up your credit score, followed by how to take charge of your finances to boost your credit to where you need it to be for your first mortgage. In this guide, you’ll learn what a credit score is, how it’s calculated, why it’s important for homebuyers, and how you can effectively improve your score. 

What’s a credit score?

Your credit score is a three-digit number that represents your creditworthiness, which is your likelihood of paying back borrowed money, debts, and bills. This number can affect whether you get a loan, approval for a credit card, what interest rate you pay, or even the types of homes or apartments you can rent. Your credit score can range from 300-900 (stay on the higher end if you can). 

Why is a good credit score important when applying for a mortgage loan?

Your credit score plays an important role in determining the interest rate and payment terms on a mortgage loan. The higher your credit score, the better chance you’ll have of securing a home mortgage at an attractive interest rate. 

What’s a good credit score when applying for a mortgage loan?

Each lender has its own standard for what credit scores they’re willing to accept, or how much risk they’re willing to take on. It’s recommended to apply for a home loan with what’s typically considered “Good Credit” or above. 

Generally, credit score ratings are scored as: 

  • 760-900 – Excellent
  • 720-759 – Very Good
  • 660-724 – Good
  • 560-559 – Fair
  • 300-559 – Poor

What’s the difference between a credit score and credit rating?

Each individual account in your credit report that contributes to your overall credt score has its own credit rating. This is basically an evaluation of how you manage the payments for that account. These ratings can range from 0 to 9 and are given one of four letters, which represent the type of credit being used: I, O, R, or M. 

R-Ratings (1-9)

  • R0: Too little credit history or credit unused
  • R1: Account paid within 30 days of due date or one or fewer late payments 
  • R2: Account paid more than 30 days past due date, not more than 60 days late, or two or fewer late payments 
  • R3: Account paid more than 60 days past the due date, not more than 90 days late, or three or fewer late payments 
  • R4: Account paid more than 90 days past the due date, not more than 120 days late, or four or fewer late payments
  • R5: Account paid 120 days late or more but not yet received an R9
  • R6: Not assigned a value
  • R7: Account holder is making agreed-upon payments through a debt-relief program
  • R8: Repossession
  • R9: Account in collections or bankruptcy. Account holder moved and did not provide a new address.

Type of Credit Being Used

  • I: Installment, meaning your loan is being repaid in fixed installments over a set period of time, such as a personal or car loan.
  • O: Open, meaning that you have opened credit, such as a credit card bill that you pay at the end of the month.
  • R: Revolving, meaning your credit card payments are contingent on your account balance. This is the most common type of credit account. 
  • M: Mortgage, which can also be represented as I for Installment.

What affects my credit score?

Your credit payment history has the highest impact on your credit score. If you pay your credit cards on time, your score is positively affected. If you repeatedly make late payments, your score often decreases. A few additional factors that can affect your credit score include:

  • Length of Credit History 

If your credit history shows consistent and timely payments over a long period of time, it’s easier for a lender to determine that you’d be a reliable borrower. However, if you have a short credit history without a great track record, your score will appear less promising. This doesn’t mean that a short credit history will prevent you from good approval odds – but a longer credit history often leads to a higher score when well managed. 

  • Credit Utilization 

Just because you have a high credit limit doesn’t mean you should try and hit that maximum spend. Credit utilization is how much available credit you’re using. You can calculate your utilization ratio by simply dividing the total of your debts by your total available credit. Keeping your credit card balances low is the best way to ensure you preserve your credit score and balance your spending – and swiping – habits. 

  • New Credit 

Nearly every time you open a new line of credit, your credit score will decrease as a hard credit pull will be required for approval. Plus, the more lines of new credit you open in a short period of time, the riskier you appear to creditors and the lower your score will be. 

  • Types of Credit 

By having a mixture of different types of credit, such as credit cards, student loans, and mortgages, you can increase your score as it shows creditors that you can manage different types of debt.

How can I improve my credit score? 

News flash – your credit score doesn’t have to be a mystery. You can check your own credit at any time without hurting your score to make sure you’re in good shape to apply for a home loan. You can get your credit score for free online through Equifax and TransUnion

To gradually improve your credit score, here are a few simple steps you can take: 

  • Pay your bills on time by setting calendar reminders in your phone or smartwatch.  
  • Keep your older credit cards open to protect the average age of your accounts.
  • Consider having a mix of credit cards and loan installments to diversify your debts. 
  • Keep your credit card utilization below 30% of your limit (ideally much lower if you can). 
  • Space out any new credit applications instead of applying for multiple new lines of credit in a short time. 
  • Ask for higher credit limits from your current credit card companies. When your credit limit goes up, your overall credit utilization ratio goes down which can improve your credit score. 
  • Dispute any credit report errors – don’t let this go as errors can drastically bring down your score.

Take Charge of Your Credit

There are lots of ways to boost your credit score and increase your chances for a great interest rate and home loan approval. Now that you have the information, turn that knowledge into power and take charge of your credit score!

Homebuyer’s Handbook

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