Home Loan Basics: Credit Considerations
To you, your credit may simply be numbers you pull through an app on your phone. But what’s behind your credit score? How is it calculated? What can increase it and what can sink it?
Your credit score is based on your current and past financial decisions. It’s a work in progress often shaped by events going as far back as 10 years.
Let’s explore frequently asked questions about how credit scores are calculated, what appears on your credit report, and how it can affect your loan application. Then we’ll review actions that may improve your credit score and others that can hurt it.
What are the U.S. credit reporting bureaus?
Equifax, Experian, and TransUnion are the three major U.S. consumer credit bureaus. They gather and maintain credit information on individuals and then sell it to other companies.
The information comes from banks, credit card companies, and other companies that offer credit to individuals. Collection agencies also search public records for property or court documentation that’s financially related.
Each bureau receives, records, and stores your credit information in its own way. The information Experian has about you will be similar but not identical to what’s reported by TransUnion or Equifax. One bureau may have information that the others didn’t find through research. Some creditors only report information to one bureau. Or one bureau may have more up-to-date information than the others.
Because of these variations, a unique credit score is generated for each bureau, based on its own information.
What are the different types of credit scores in the U.S.?
Analytics software is used to convert your credit information into a credit score. There are hundreds of different credit scoring models, with FICO and VantageScore being some of the most widely used. Their scores range from 300 to 850, with higher scores being optimal.
FICO breaks them into the following segments:
- 800 to 850 – Exceptional
- 740 to 799 – Very good
- 670 to 739 – Good
- 580 to 669 – Fair
- 300 to 579 – Poor
VantageScore breaks credit scores into slightly different segments:
- 781 to 850 – Exceptional
- 661 to 780 – Good
- 601 to 660 – Fair
- 500 to 600 – Poor
- 300 to 499 – Very Poor
How do credit scores affect loan applications?
In general, the higher the credit score, the lower the interest rate. Lenders view your credit score as a reflection of your credit worthiness, and you can expect to be offered the best interest rates when you score 740 or better. In contrast, when you have a poor credit score, the interest rate you are offered may be one of the highest –if you’re offered one at all.
A high credit score may give you access to more product options and qualify you for a larger loan. On the other hand, a low score can limit you to just a few products. However, a low score doesn’t mean that you won’t have any mortgage options. For example, borrowers with a credit score of 500 meet the minimum eligibility requirement for an FHA loan.
A great way to ensure a higher credit score is by building your credit score as early as you can.
What is the tri-merge credit report?
After you apply for a home loan, the lender will ask your permission to pull a credit report. Many use a tri-merge credit report, which merges all your credit information from Experian, Equifax, and TransUnion into a single report. It also includes an individual credit score from each credit bureau.
What information is included in credit reports?
Credit reports are often broken into several sections, including those listed below.
Personal and Employment Information
Your personal information is used to verify your identity. You’ll find your name and any variations of it that you have used. This could include misspellings of your name. Your current address is listed as well as your birth date.
Some of your employers might be listed, but it is not a complete history. It’s limited to the employers you identified on past credit applications. Lenders aren’t required to report this to credit bureaus, so it often doesn’t make it on your credit report.
Your account history is typically the largest section of your credit report. Open and closed accounts are listed here.
Each listing includes the name of the creditor, account balance, limit or original loan amount, account status, and payment history, including late payments. Information about collection accounts will be included.
Lenders pay a lot of attention to this section, making note of any negative information.
This section includes information about bankruptcies, liens, and judgments that appear in court records. This type of information varies from state to state based on what is allowed as public record, but it will always be financial in nature – criminal records won’t appear on your credit report.
Public record information is typically reported for up to seven to 10 years. A Chapter 13 bankruptcy remains on your credit report for seven years and a Chapter 7 for 10 years.
How soon can you buy a home after a bankruptcy? It depends on the type of bankruptcy, the loan program and the lender, but you can expect a minimum of two years in many cases.
Collection accounts, loan defaults, repossessions, and other negative information remain on your credit report for a minimum of seven years.
In addition to bankruptcies and judgements, other derogatory items are found on your credit report, such as past due accounts, accounts in collection, loan defaults, debt settlements, repossessions, and foreclosures.
These items have a negative impact on your credit score and often remain on your report for a minimum of seven years. Lenders will review this information carefully.
Like a bankruptcy, the effect of derogatory items on your loan application depends on the lender and their guidelines.
A credit inquiry is generated each time you apply for a credit, whether it’s for a credit card, a line of credit, or a loan. Applying for several accounts in a short period of time can lower your credit score, with each inquiry dropping your score about five points.
However, if you’re shopping around to find the best fit for a loan, the multiple inquiries will often be grouped together for credit scoring, creating a lesser impact on your score. Inquiries remain on your credit report for about two years.
This section lists your current and prior addresses as reported to the credit bureaus. Although this is often a small section of your report, it’s an important one.
Your lender will carefully review this list to confirm the addresses match what you provided on your application. A missing address could indicate you have ownership in another property and possible debt associated with it.
What is a Letter of Explanation (LOE)?
When you apply for a home loan, you can explain any issues they found on your credit report. This is done through a Letter of Explanation (LOE). The best LOEs are simple and concise and provide documentation that supports your explanation.
You can use an LOE to correct minor reporting errors, such as discrepancies in your name and address. You can also use it to provide details or a more serious issue, such as a collection account or bankruptcy.
What factors negatively affect credit scores?
With credit scores playing a large impact on mortgage qualification and pricing, it’s important to pay attention to key credit score factors. Here is what can bring your score down.
Poor Payment History
Your payment history is the largest component of your credit score. Lenders want to see that you pay your bills on time. A single late payment of 30 days may not affect your credit score, but a pattern of late or missed payments will.
Overdue accounts, collection accounts, debt settlements, repossessions, foreclosures, tax liens, civil judgments, and bankruptcy also hurt your credit score. In most cases, this negative information is reported for a minimum of seven years. Chapter 13 bankruptcies are reported for 10 years.
Having a poor payment history doesn’t automatically disqualify you for a loan. It depends on what the lender finds acceptable. But if credit is offered to you, it may be at less favorable terms and at a higher interest rate.
High Credit Utilization
Individuals who max out their credit cards are perceived as higher credit risks, so having a high credit utilization ratio can hurt your credit score. Your credit utilization ratio is how much of your available credit you are using.
To get this ratio, take the total balances of your credit cards and lines of credit and divide by the total of their limits. For example, if your credit card balance is $3,000 and your limits total is $10,000, you are utilizing 30% of your available credit.
It’s often recommended that you keep this percentage below 30%.
Too Little Credit
Having too little credit can also lower your credit score. Generally, you need a minimum of one bureau reported account, open for at least six months to calculate a credit score. And a lender will likely want to see more, a minimum of three active trade lines — credit cards, lines of credit, and loans — on your credit report.
This provides more history of how you manage your debt successfully. Not having history can affect your ability to get credit. However, opening numerous accounts at once is not recommended.
Opening or Closing Trade Lines
Because new accounts offer very little payment history and are often viewed as a risk factor, they may lower your credit score. When possible, you should avoid opening new trade lines at least six months prior to applying for a mortgage.
Closing credit cards and other trade lines with a good payment history can be a mistake, too. Trade lines, especially older ones, can help boost your credit score if there’s been some activity on them in the past year or two.
What steps should I take before applying for a loan?
Review your credit report to identify and correct errors. This can increase your chances of being approved for a home loan and other forms of credit. It may also improve your credit scores and allow you to qualify for the best loan terms possible.
The process can take some time. So, do your review well ahead of your loan application, rather than during the approval process.
It may not be glamorous, but keeping a watchful eye on your credit report can help you reap the benefits of a high credit score.
Get a Free Credit Report
With your credit report playing such a big role, it’s important that it’s accurate. You’re entitled to a free credit report every 12 months from each of the three credit bureaus. The Federal Trade Commission (FTC) provides a link on their Free Credit Report page to AnnualCreditReport.com which is the official website for free credit reports.
For individuals who prefer to call, a phone number is also provided on the website. You’ll be asked to provide your name, address, Social Security number, and date of birth, regardless of the method you choose.
Credit Score Monitoring
Don’t wait to check your credit score until right before a major financial decision. Keeping track of how your credit changes should be a frequent part of your routine. Checking your credit frequently can help you correct bad habits and catch reporting mistakes before it’s too late.
Resolve Inaccurate Information
If you find errors on your credit reports, you can request corrections. Notify the credit bureau and the company that provided the information.
After receiving notice of the disputed information, the reporting company must investigate and report back to the credit bureau. If the disputed information is confirmed to be inaccurate, the reporting company must notify all three credit bureaus so your information can be corrected.
The FTC is an excellent resource for detailed information on Disputing Errors on Credit Reports.
Axos Bank Is Here To Help
A high credit score and strong credit history can open the door to buying a home. They show lenders you can be trusted to pay your bills and manage your debt successfully. You can use it as a tool to meet your current needs, unlock future opportunities, and build a more secure future.
If you’re ready to explore home loan options, Axos Bank’s expert mortgage team is here to answer your questions and tailor a loan that meets your unique needs. Call 888-546-2634 to speak with an experienced mortgage specialist today.
Home Loan Basics: Credit Considerations
This blog post was published by Axos Bank on July 9, 2019 and last updated on July 19, 2023.
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