Getting the best possible interest rate for your home mortgage requires having a good credit rating or credit score. Although the lender will ask for several financial details, the credit rating is the primary financial information that could potentially dictate how much the interest rate will be.
Credit rating is a numerical figure reflected in a credit report. This rating or score could run between 300 and 850, the exact figure of which will depend on the agency in charge of the scoring. In a nutshell, a high number indicates a good credit rating, which could give you the best scenario when it comes to home loan application.
Some home buyers are familiar with the term “credit rating”, but there’s another term that relates to this credit evaluation figure called “FICO score”. These two terms are interchangeable and refer to the same thing. FICO score came from Fair Isaac Corporation, which created the first recorded credit score back in the 1980s. This number is considered an industry standard, and is indicated in your credit report. There are three reporting companies that issue credit ratings or FICO scores: Equifax, Experian, and TransUnion. These three groups generate independent credit ratings, and as a result, your credit report may have three FICO scores.
A FICO score comes from the following criteria:
- 35 percent from your payment history: Did you fulfill your payment obligations on a timely manner?
- 30 percent from debt profile: How much debt do you owe?
- 15 percent from duration of credit history: How many years have you borrowing from lenders?
- 10 percent from new credit: Do you have newly applied credit?
- 10 percent from credit types: Are your credit types varied, such as credit cards or loans?
How high is a “high score”?
The base FICO scores can run between 300 and 850, but your aim should be a high score. There’s no such thing as a high score requirement, but each lender has a preferred score before they can approve a loan application. Many lenders can give you acceptable interest rates for your mortgage when you have a score of at least 720. If it’s your first time to purchase a home, the Federal Housing Administration (FHA) can grant you a loan as long as you reach a score of 630 or more.
Self-employed individuals cannot present verification for their income, but they can still apply for a no-income-verification loan. FICO score requirement for this kind of loan is pegged at 680 minimum, although don’t assume that all banks will grant your loan request. If you don’t have problems with your credit history, then you have little to worry about. Just make sure that you can present a credit report, because majority of home loan providers have become more stringent after the financial crisis of 2008.
Of course, if you can achieve the 850 score ceiling, you can bet your horses that lenders will slam their stamp of approval onto your application! However, the median FICO score in the U.S. is 723, which is already a good score for many lenders.
Even if you haven’t received your credit report yet, you may do a self-assessment to check if you are eligible for home loans. For starters, paying your bills on time and maintaining a variety of credit types could possibly give you a high score. Are you frequently receiving credit card offers at zero percent interest or loan offers at very low rates? That means your credit standing is probably good.
Do you need to pay for your credit report?
Absolutely not! You are entitled to receive a copy of your credit report once a year from each of the three consumer reporting bureaus, as supported by the Fair Credit Reporting Act (FCRA). All you need to do is file a request to get a copy, free of charge. To request for your free credit reports, check out the Annual Credit Report website, which is authorized by the Federal Trade Commission. The agency also provides a brochure (Your Access to Free Credit Reports) to explain home buyers’ rights under the FCRA.
Does a poor credit record spell the end of the world?
Before you go all ballistic and panic at the sight of your credit report, don’t lose hope. Some financial institutions still accept loan applications from people who have low credit ratings. You may also do the following actions to make your next credit report a whole lot better:
- Pay your bills on time. Make sure that the credit card company doesn’t earn much from your balance. At the very least, pay the required minimum balance on or before the deadline.
- Aim to gradually decrease the balance. Have a few extra bucks to give? Instead of buying that extra pair of shoes, use the money as additional payment for your credit card balance. The best thing to do, of course, is to settle the entire debt altogether.
- Don’t maximize the credit limit. Sure, you’re given some leeway to spend using your card, but maxing out on your credit card could make your credit report suffer. Try to limit your spending so that your credit card balance doesn’t eat up the credit line. Using up 80-90% of your allowable credit speaks much about how you badly you handle your finances.
- Decline offers for new credit cards. Some credit card company marketers have amazing persuasion abilities that make you want to apply for a new card. Hold that thought! Having a lot of new cards – especially right before buying a home – may discourage some lenders.
Alas, if you really find it difficult to improve your FICO score, your best option is to apply for a FHA loan. FHA requires a minimum FICO score of 580, and will grant approved applicants a down payment of 3.5 percent. Prospective buyers with lower credit ratings will have to shoulder down payments of not lower than 10 percent.
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