Credit Scores – How Do They Apply To Mortgages?
The web is full of articles about credit scores; getting them for free, improving them, what to do if you don’t have great credit. But there are some FAQs that are specifically related to applying for a mortgage.
Three Different Credit Bureaus
There are three different “major” credit bureaus, and usually your score with each will be slightly different.
Some lenders use a combined report and look at all three scores, and some favor one score over another. You won’t get to choose which bureau is used. The good news is; all scores fall within a common range of 300 – 850. If you have good credit, you’ll probably be considered “good” in all three places. If you have bad credit, you’ll be considered “bad” across the board.
As defined by Transunion, “Your credit report is a record of your credit activity. It includes the names of companies that have extended you credit and/or loans, as well as the credit limits and loan amounts. Your payment history is also part of this record. If you have delinquent accounts, bankruptcies, foreclosures or lawsuits, these can also be found in your credit report.”
So Why Do the Scores Vary?
Companies report payment data to at least one credit bureau each month. However, they may not report to all three, and they may report on different days. This is usually why your credit score varies. In addition, the credit bureaus each use a slightly different scoring model. But the lender determines the range for score levels: poor, fair, good, or excellent. Unless your score is right on the line, the variance between bureaus shouldn’t have a significant impact on your mortgage being approved or declined.
How Are Credit Scores Calculated?
Each bureau has its own methods for arriving at the actual scores. Various aspects of your “loan life” are taken into account including:
- Payment history
- Percentage of credit used
- Age of credit
- Public records
- Inquiries (representing each time someone checks your credit)
Each item carries a different weight that can help or hurt your credit. “Number of Inquiries” is one you hear about all the time, and in fact, multiple inquiries over an extended period of time (a week, two weeks, a month, etc) can have a negative impact because it gives the appearance that you are always looking for more money. Multiple inquiries within a day or two isn’t bad, but stretched out across weeks or a constant trigger is not looked at favorably. This is a great reason not to apply for every credit card ad you see or receive in the mail. Paying credit card debt in a timely manner, is far better than having no cards, or carrying no balance. Closing out a bunch of credit cards can hurt your credit since it reduces your available balance, and may change the age of your oldest credit line (the older the better). Payment history is a part of your credit score, so using the credit cards, and paying them off on time is a plus for your credit score.
Can I Get a Mortgage With Bad Credit?
Maybe. In fact, there are mortgage programs available for people with “fair” or even “poor” credit scores. Bankrate indicates that many people with lower credit scores obtain mortgages through FHA. Mortgage rates (the annual percentage rate) may be higher, the down payment requirement may be higher, but you will be given the chance to explain the situation, and provide supporting documentation to prove your credit worthiness. Being able to prove 12 months of on time rental payments can be a significant game changer if you have minimal credit and want a mortgage. Also, ask your lender if they are using an automated underwriting system or will also do a manual underwrite. With the automated system, (usually FNMA or FHLMC) a system makes a decision on your application based on specific criteria for credit scores, income, debt ratios, etc. Manual underwriting allows for unusual circumstances, or those that require a bit more explanation.
If you are asked to provide an explanation for bad debt, be honest. The lender wants to know that this was a one-time occurrence, due to extenuating circumstances; a family illness, a job loss, a problem with an insurance claim. Payments that are late because of too much debt, holiday spending, or vacation will be seen negatively by the lender and tell them that this could happen again, and will lead them to believe that you haven’t yet learned to manage credit and repay loans responsibly. A bankruptcy or foreclosure on your credit report may result in your not being able to obtain a mortgage.
Remember, a loan is a legal guarantee that you will repay the money being borrowed. If you are borrowing money to purchase a home or condo, technically that property belongs to the lender until you’ve paid off the loan. If you don’t pay the loan, you could lose the home and that has an extremely negative effect on your credit score.