UNDERSTAND YOUR CREDIT SCORE SO YOU ARE HOME-PURCHASE-READY
If you Google search “credit score”, almost 5 million answers pop up. Yikes! How do you make sense of it all? If you have a banking app, credit card app, or any of the modern financial trackers like Credit Karma® and Mint®, you could check your credit score every day, multiple times for free. Hopefully, you’re not addicted to it like Fortnite® or Call of Duty®!
However, being aware of how to build your credit score is super important. If you are one of the people who would rather own a home than save the world (based on a recent TMS survey of first-time homebuyers), then you need to get your credit home-purchase-ready.
While there’s certainly no shortage of wisdom to help you try to figure it out, we have 20 years of experience helping people achieve their dream of homeownership. So, we’re going to cut to the chase to tell you what you need to know, and hopefully debunk a few myths along the way. (Sorry mom and dad…a few things have changed since you bought a home.)
What is FICO?
Well, it’s not a Fortnite victory dance…but if you have a high score, you may feel like busting a move! FICO is the largest and best-known company that calculates credit scores. There are three bureaus who report your credit score: TransUnion®, Experian™ and Equifax®. Lenders use these scores to determine the likelihood that you will repay the loan. The range is 300 to 850. Keep that range in mind – there’ll be a quiz later.
How do they create the score? Any credit you have might be reported to the bureaus: mortgages, credit cards, auto loans, student loans, department store credit cards, and more. Different creditors may report different data to the bureaus, and some may not report to a bureau at all (if it isn’t required).
Based on what’s reported each month, the bureaus take into account how long you’ve had credit, how much credit you use, what type of credit (there’s good credit and bad credit), and any payment patterns, such as on time or late payments, delinquencies and more. Then, they calculate a score for you until their next round of reviews.
What we want to focus on is how you can increase your score
First off, you can only have a credit score by having a credit history (and most lenders will require a credit score). Take a look at our list from earlier again – you can build credit by having a mortgage, credit cards, auto loans, student loans, department store credit cards, etc. Once you have a score, the next thing you’ll need to pay attention to is a good borrowing performance.
How do the bureaus size up your performance?
It’s as simple as looking through your history. They’ll answer a few questions, like are you making payments on time? If not, how late are your payments? How much do you owe? How recently have you missed a payment? How many late payments have there been? These questions all play a role in your final number.
Keep your usage under 30%
The next big chunk of your score is centered around your credit usage. Want to know something surprising? Credit usage is determined by each account, not overall. Who knew?! Let’s say you have a credit card with a $500 limit and you use $400; the credit bureaus see that you used 80% of that account (even if you pay it off each month). It’s smart to keep your credit usage under 30% for each account.
The good news, though? Installment loans generally aren’t factored into your usage. Whew! Installment loans, like mortgages, student loans, and auto loans, have a fixed amount and are paid back with regularly scheduled payments (those of you with these kinds of loans know ALL about those regularly scheduled payments). Since these can start off with pretty hefty balances, they aren’t usually included in the average usage calculation.
You might also be interested to know, as of 2018, charge cards like AMEX are not generally included, either. Since they don’t have a pre-set limit, there’s no easy way to figure out utilization.
Age is more than just a number
Think back to how excited you were to turn 21. You should be just as excited for your credit history to age. Like a fine wine, your credit could get better as it ages. A long credit history may show that you’re an experienced borrower (as long as it’s a good history). So refined.
You might be tempted to close old accounts if you haven’t used them in a while, but you may want to at least keep your oldest account open to keep your “old age”. Just keep an eye on any annual fees.
Ok, mom and dad, this is the part you’ll want to pay attention to. A great way to increase credit age is by becoming an authorized user on someone else’s card. Someone with strong credit. Someone…older, and wiser (hint, hint). If a parent has 20 years of credit history and their child joins their account, it’ll look like the child has 20 years of credit history. And the even better news? There’s no age cutoff to be on someone else’s account. A 40-year-old could still be an authorized user on their 70-year-old parent’s credit card.
What should you consider when making this decision? Make sure the account holder has good credit. You’ll also want to keep in mind that the account holder is responsible for the authorized user’s debt, so have a plan in place before adding someone to an account. Lastly, debts from both parties are counted in each party’s credit assessment, and debt from both parties will be factored into each party’s usage.
To be clear, your son or daughter won’t inherit your credit score (each person has their own individual credit scores, even married couples). But their credit history may be negatively impacted if you have late or missed payments, and vice versa. In the event that they’re taken off of your account, their age of credit would go down to their actual credit age (i.e. your child has 2 years of credit history on their own). Make sense?
Now, these next two things aren’t quite as important as what we’ve already talked about, but they’ll still impact your FICO score.
One small factor is your credit mix. Sorry to get all technical on you, but having a mix of revolving and installment accounts could be a positive thing. We already talked about installment accounts earlier, so let’s go over revolving now. Revolving credit is a credit line you can borrow freely from, but it has a limit. Think credit cards and home equity credit. Revolving accounts can show that you’ve managed credit responsibly.
Finally, you’ll need to be careful of new credit. What do we mean by that? Opening or requesting too many new lines of credit may send a red flag to lenders. Think about it – the more money you have to spend, the more likely you are to spend it. Newer accounts may also lower your average credit age.
Ok, we’re almost done
Remember way back at the beginning of this article when we said credit scores range from 300 to 850? Good. Having a decent credit score doesn’t necessarily guarantee you the best interest rates. However, the fact is, the higher your credit score, the more likely you are to qualify for a loan and, in some cases, even get a lower interest rate. That’s pretty important when it comes time to, say, buy a house. But, there’s good news for those with lower scores – FICO isn’t the only thing your lender is looking at.
Your credit report is like a financial report card
Most lenders will look at your credit report – also known as a detailed history of your credit. They’ll see your balance, monthly payments, and any delinquencies. Some lenders may even go over your report with you to give you an understanding of your score. They might be able to give you some insight about certain things that are negatively or positively impacting your score. If your lender is willing to do this, listen up!
What can you do to be home-purchase-ready?
Cleaning up your credit won’t happen overnight, but it can happen.
- Check your credit report once every 12 months to make sure there aren’t errors. Mistakes do happen, and you don’t want to pay the price for an oversight. You have the right to dispute errors by contacting the credit reporting agency that provided the wrong information. Also, take this time to see if there’s anything you can fix or improve.
- Set up payment reminders or automatic payments to pay bills on time. Mark them on your calendar if you need a gentle reminder to check your balance once in a while.
- Keep revolving credit balances low.
- Apply for new credit accounts only when you absolutely need to.
- Make late and missed payments as soon as possible. It’s a bigger deal to miss four months of payments than to be 30 days late.
- Give your lender a call if you’re having a hard time making payments.
So, what are you waiting for? Head over to check your FICO scores (if you haven’t already) and find out where you stand. AnnualCreditReport.com offers a free report once a year for each bureau (but you’ll still have to pay to see your actual score). If you want to check it as often as you play Fortnite, take a look at some of the great app options out there.