You’ve probably seen a few commercials designed to push you to take that leap and go after your dream home. However, what these marketers don’t tell you is that this journey is wasted without a great credit score. Unless you have enough cash to buy the home outright, one of the first questions you should ask in your home journey is what is my credit score and how is it calculated? Your credit score is one of the most important pieces of data banks use when making their decision on whether to lend to you and at what rate they will provide you on your mortgage. The importance of a top tiered score versus the next tier down can be the difference of saving thousands of dollars on your mortgage!
How is my Credit Score Calculated?
Two companies, FICO and VantageScore, have come up with a methodology that analyzes all of your various debts (credit cards, home loans, car loans, student loans, etc.) to calculate your credit score from 300 (poorest) to 850 (excellent credit). Your personal financial information used to compute these scores comes from the three main credit bureaus who collect this information – Equifax, Experian, and TransUnion.
What does my Credit Score Mean?
- A credit score above 800 is considered the highest tier and will qualify you for the best rates available.
- A credit score above 740 tends to also qualify for this top rate, assuming the other pieces of your application are also strong.
- A credit score between 670 and 740 is considered a good score and will be strong application, though you likely will not qualify for the lowest available rate.
- A credit score between 580 and 670 is considered fair credit, and may or may not qualify for a conventional loan. Those with credit scores in this range may want to consider a government sponsored loan such as FHA, VA, or USDA.
- A credit score below 580 is considered poor and generally will not qualify for a loan.
What Does that Translate into for My Savings?
Banks are eager to lend to those with the best credit scores as they deem those to be safer borrowers. As a result, they are able to offer lower rates to these qualified borrowers. For example, it is common to see someone with a top tier credit score (above 800) receive a 0.25% lower rate than those with the second highest credit tier (above 740). Let’s take a look at how this would affect someone with a 30-year $300,000 mortgage who received a 2.75% rate rather than a 3.0% rate. While a quarter point of interest doesn’t seem like much, it represents the difference of $40 a month savings, translating into a total savings of $14,400 over the life of the loan!
The numbers add up significantly for those with larger mortgages. For example, comparing the same 2.75% versus 3% rate on a 30-year $1,000,000 mortgage creates a monthly savings of $134. The savings over the life of this mortgage would be nearly $50,000, or $48,240 to be exact! Using a mortgage calculator is the best way to estimate the savings for your own situation.
What Goes into Calculating my Credit Score?
There are 5 key components that make up your credit score. They include:
- Payment History (35% of the score) – How on time your payments have been.
- Amount you Owe (30% of the score) – How much of your credit lines you are utilizing.
- New Credit Opened (10% of the score) – How often you are applying for new credit.
- Length of Credit History (15% of the score) – How long your accounts have been opened.
- Types of Credit (10% of the score) – How diversified the different types of debt you have are (i.e. having more than just credit card debt).
So Where Do I Find Out My Credit Score?
Finding your credit score is much easier than you think. There are tons of free credit score websites. That being said, do you have a credit card or bank account? Many credit cards and banks provide your credit score simply upon logging into your account. On a side note, you may have heard that checking your credit score can potentially harm it. Not to worry as that isn’t the case with simply checking your credit score. Checking your score will have no negative repercussions as it is a “soft inquiry”!
How Do I Get a Free Detailed Credit Report?
It’s always a good idea to check your detailed credit report to ensure your profile is accurate, particularly when applying for a mortgage loan. You are entitled to one free report annually from the official site designated to provide you a free report. Your credit report will contain data from all three bureaus so you can see if one or more of them have incorrect information.
Can I Improve my Credit Score?
Yes! While your credit score is a cumulation of years (or decades) or data, there are some short term actions you can implement to boost your credit score. These actions will not turn a poor credit score into a great one overnight, but they can be the difference of adding 20-40 points to your score. This may be enough to push you into the next category and earn a lower rate that could save you thousands in mortgage payments! Simple actions such as paying off your credit cards before the monthly statements is over and not opening new lines of credit can go a long way to potentially pushing you into the next tier!
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