Your credit score is one of the major factors used to secure a loan to buy a house. The higher the score, the better chance at getting a low mortgage rate. A low credit score means a higher mortgage rate, or worse— it could prevent you from getting any type of mortgage loan at all. Potential home buyers often are told to check their credit score before they consider a home search. But here are some surprises a potential buyer could face.
Surprise #1: Not All Credit Scores are Created Equal
Technology advancement has resulted in more companies offering a “Credit Score” for free. Download an app, provide personal information, and boom, there’s your credit score. The problem with accessing a credit score this way is that it’s not always accurate in terms of the way home loans are secured. Often times, the score will be higher than those provided by the three credit reporting companies used by most lenders (Equifax, Experion, and TransUnion). Why? Not all credit scores are based on the same “ingredients.” Companies such as Credit Karma and Discover use a different set of criteria as well as their own algorithm to determine a credit score. One might argue these companies have an interest in providing a rosy picture of credit because their business model is sustained by advertisers who want to get in front of a specific audience on a regular basis. Even Equifax, Experion, and TransUnion, each also with their own proprietary algorithm, do not deliver the same credit score for a single individual because not all creditors report to the same agency.
Surprise #2: Your Pre-Qualification Might Be Useless Once You’ve Signed a Purchase Contract
Every time a lender pre-qualifies an applicant for a home loan, they incur a charge from each reporting agency for pulling credit. Because not all applicants will make it to closing, some lenders only pull credit from one credit reporting agency—Equifax, Experion, or TransUnion—instead of all three. As a buyer, you’ll typically sign a home purchase contract with the contingency of loan approval. When it comes time to underwrite the loan, credit will be pulled from all three reporting agencies and the median score will be used. If that score is significantly lower than the one the lender used in pre-qualification, you might not qualify for your loan, or you may need to take on a higher mortgage rate.
Surprise #3: You Might Not Be Able to Improve Your Credit Score as Fast as Needed
The fastest way to improve a credit score is to pay off the balance on all credit cards and remove collections and any other derogatory items on your accounts. However, for many people with troubled credit scores, this is too big a challenge to tackle in a short period of time. Improving a score could take months or years, depending on one’s situation.
For people who are in a position to pay off credit cards for a quicker credit score improvement, note that the process may take a few weeks to a month. When paying off credit cards, many people mistakenly believe that their new balance is immediately updated with the credit bureau. It’s not. Creditors typically only update accounts with credit bureaus once per month. So if you’re in a pressure situation to improve credit fast in order to secure a specific mortgage rate, realize that turnaround time is going to be more than a few days.
How Do You Avoid These Surprises?
If you want to monitor your credit score, go to myFICO.com. FICO scores are used by 90% of top lenders. and are most widely used in mortgage lending. There is a fee for monitoring, but you’ll be in a better position to avoid a misleading score. You can also get free credit reports from Equifax, Experion, and TransUnion once a year at AnnualCreditReport.com so that you can identify errors or derogatory items that you need to address.
Make sure you get a pre-qualification from a lender that pulls credit from all three reporting agencies. Better yet, get pre-approved rather than pre-qualified – it’s a more accurate dive into your creditworthiness.
Obviously the best way to increase or maintain a favorable credit score is to be responsible with your finances. Pay bills on time. Keep track of the amounts you owe to each creditor. Scoring is higher if you owe less than 30% of your available credit per account. Credit history is also key – the longer your history, the better your score. Credit mix is important too because it indicates you can balance an auto loan, student loan, and other type debts all at the same time. Finally, refrain from taking out new credit, especially when buying a home. Too many new accounts opened in a short period of time is seen as a negative risk that can hurt your score.
Real Estate Term of the Week
FICO Score: A three-digit number based on the information in your credit reports. It helps lenders determine how likely you are to repay a loan. This, in turn, affects how much you can borrow, how many months you have to repay, and how much it will cost (the interest rate). FICO Scores are the industry standard for making accurate and fair decisions about creditworthiness.