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Understanding Your Credit Score

Mortgage Education Lesson #3

When it comes to qualifying for lower mortgage rates, there is no more important piece of information than your credit score.

  • What is a credit score?
  • Why is my score important in the mortgage process?
  • Do’s and Don’ts of managing your credit score

What is a credit score?

Your credit score is a three-digit number between 300 and 850 that is calculated by a mathematical algorithm. Three major credit bureaus gather information about your spending habits, your history of borrowing, and your ability to repay. Those three bureaus are TransUnion, Equifax, and Experian. You have probably heard of a “FICO credit score,” which stands for the Fair Isaac Corporation, the company that actually takes the information gathered by the three bureaus and calculates it into one credit score.

Credit Score Scale

Take a closer look at the parts of your credit history that factor in to your credit score calculation.

  • Payment history: Whether you pay on time and more than the minimum amount.
  • Amounts owed: Do you have a balance on any of your accounts? Do you have high credit limits on those accounts and are you almost at the limits?
  • Length of credit history: How long have you had these credit accounts? Have you had good standing relationships with financial institutions for several years?
  • Types of credit used: The different types of credit you utilize—such as credit cards, automobile loans, student loans, etc. New credit: Have you opened any new lines of credit recently?
Credit Score Factors

Why is my credit score important?

The reason your credit score is so crucial in the mortgage loan process is that a low credit score could disqualify you for financing because it demonstrates your ability to borrow and repay money responsibly. Also, the higher your credit score, the lower your interest rate could be, meaning that you could end up paying less in total interest over the duration of your mortgage.

Take note of our 30 year mortgage loan example, and the difference in interest you’d pay with a 5.5% interest rate ($290,000 in interest over 30 years) and with a 3.5% interest rate ($190,000 over 30 years). That 2% makes an enormous difference.

Credit Scores Impact on Interest Rates

Do’s and Don’ts of Managing Your Credit Score

Do use a mix of credit accounts, such as vehicle loans, personal loans, and student loans, and other mortgages.

Don’t exceed the maximum available credit limit on any of your credit cards.

Do keep a small balance (no more than 30%) on your credit cards and make your payments in full and on time.

Don’t open a new line of credit right before beginning your mortgage application process as it may impact your credit score negatively.

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