How Your Credit Score Affects Your Mortgage Loan Application and How to Improve That Score

One of the biggest factors affecting your ability to get a loan will be your credit score. Your credit score will also affect the rate you get on any loan, the terms of the loan as well as what loan programs will be available to you.

As I’ve mentioned before if you’re starting the process of buying or refinancing it’s a good idea to take a look at your credit first so you address any potential problems in the report.

Your credit report includes information like:

• Your name, address and social security number
• Your employment history
• A record of specific credit transactions
• A record of credit inquiries that have been made

The credit report is basically a snapshot of your credit history looking at how much you’ve borrowed in the past, how reliable you were in making payments and whether or not the debt was paid off on time. Any institution granting you credit will want to know ahead of time whether you are a reliable borrower or a risk.

Today’s credit scoring methodology was originally developed by Fair, Issac & Company, Inc. You may have heard of it as your FICO score. The methodology was developed for the three big credit reporting agencies Experian, Equifax, and TransUnion. The credit score is a statistical analysis of your payment history including any late or missed payments, the amount and number of debt payments you have, any bankruptcies or derogatory events, and some public records.

The credit score is a reflection of your credit history and does not take into account your income, any checking or savings accounts, or other financial investments. The five factors affecting your credit score are:

1. Payment history – 35% of your score
2. Outstanding balances – 30% of your score
3. Length of credit history – 15% of your score
4. Type of credit – 10% of your score
5. Age of credit– 10% of your score

Your credit score will fall somewhere between 300 and 850. Borrowers on the low end of the scale (under 600) are generally considered to be the greatest risk and will have fewer available loan programs, higher rates and fees, and they may need to provide additional documentation. Borrowers on the higher end of the scale (above 700) are generally considered to be lower risk and will have more available loan programs to choose from as well as lower rates and fees. Lower risk borrowers may also have access to more streamlined underwriting and approval systems.

*There are a number of things you can do to improve and/or maintain your credit score:

• Pay all your bills, not just credit card bills, on time every month – a long history of making payments can improve your credit score
• Do not max out all your credit cards – keep outstanding balances low on revolving credit, below 30% of the limit
• Aim to pay off of individual debts – a history of paying off debt is important
• Don’t close long-established accounts – the longer your credit has been open the better
• Do not apply for credit you do not need, won’t use or could negatively affect your credit score
• If you are delinquent work with the creditor to make payments and get back on track as soon as possible

It is also important to think about how the same action can affect your credit score over time. For example applying for credit can have a negative short-term impact on your credit score but having that credit available over time could have a positive long-term impact because it will improve your credit utilization rate.

What’s a credit utilization rate?

The credit utilization rate is an equation used by the credit reporting agencies that compares how much you owe to your overall available balance. It’s the sum of your revolving debt divided by your total available credit.

Here’s an example. If you have $6,000 in total credit card debt with an overall available credit limit of $20,000 you have a credit utilization rate of 30% ($6,000 / $20,000 = 30%). You are using 30% of your available credit.

But if you had $12,000 in total credit card debt with an overall available credit limit of $20,000 you would have a credit utilization rate of 60% ($12,000 / $20,000 = 60%). You are using 60% of your available credit.

A high credit utilization rate (like 60%) will lead to a lower credit score while a low credit utilization rate (30%)  will lead to a higher credit score. That is why it’s important to not max out your credit cards and to keep your balances on outstanding debt low.

It’s also a good idea to keep a couple paid off credit accounts open. Having long-standing, paid off accounts with available credit can improve your credit utilization rate and your overall credit score. Another reason to maintain long-standing credit accounts is that the credit scoring models reward borrowers with long credit histories. Of course, you should only retain these accounts if you can resist the temptation to use that credit to make unnecessary purchases.

You are entitled to one free copy of your credit report annually. To receive a copy of your credit report you can go to: www.annualcreditreport.com or by call 877-FACT-ACT.

Here’s a tip from personal experience. Do not get talked into providing your credit card number or other unnecessary personal information in exchange for a copy of your credit report. My wife did this. She was trying to get a copy of her credit report and didn’t realize she was signing up for a credit service. Many of these credit service companies are shady at best.

She gave the service her credit card number, got her credit report and the next month she was charged for the credit service. To say that she was mad is an understatement. Then she had to argue extensively with the company to cancel the service which only compounded her anger.

Here’s another tip from personal experience. If you are signing up for doc-less or email only statements or communications make sure you check those email accounts. When we transitioned from one Internet Service Provider (ISP) to another I set up the account online. I opted out of receiving paper statements through the mail, selected to have payments made automatically from our bank account, gave the ISP the email account I use for spam and didn’t think much of it.

A couple months later I happened to log onto the ISP account and noticed we had late payments. Turns out I had given the ISP the wrong routing number for the checking account and the bank had denied payment. Because I had opted out of paper communications the ISP couldn’t send me anything meanwhile the emails they were sending were going to an account I rarely looked at.

Fortunately, neither of these examples were detrimental to our credit.

For more information on the individual credit reporting agencies or improving your score check out the following:

• http://www.experian.com
• http://www.equifax.com
• http://www.transunion.com
• http://www.myFICO.com/crediteducation/improveyourscore.aspx

For more information contact Aaron Walker or Jay Rapson at Aaron Lending, LLC.

*We are not licensed credit counselors nor do we play them on television. If you have a severely low credit score it might be in your best interest to seek out a licensed credit counselor.