Understanding Your Credit Rating and What it Means to You

      Perhaps the most important factor in obtaining a good interest rate on your mortgage is your "credit history."  We'll try to help you here to understand your credit rating and the mortgage terms you can expect from a lender based upon your credit rating or "credit score".

      When you apply for a mortgage from a lender or broker, by far the most important factor is your credit.  In some cases, your ability to get a mortgage is determined entirely by your credit.  Generally, there are other factors but your credit rating is probably the single most critical factor that determines whether you'll get a mortgage loan at all and at what interest rate you will get the mortgage.  The better your credit rating and the better you manage your credit, the lower your mortgage interest rate will be.

Before You Start Looking for a Home

      Before you start looking for a home, take the time to order your credit report from all three major credit reporting agencies.  The three major credit reporting agencies are:

A General Guide to Credit Ratings

      First a definition -- your "credit rating score" is generally expressed as a "FICO score"  FICO stands for Fair Isaac Credit Organization, a standardized way of expressing your credit worthiness.  It's a measure of the risk a lender is taking in providing you a loan.  Your credit risk is calculated from a credit report using a standardized formula.  

      To develop their specific credit scoring model, each mortgage provider selects a random sample of its past and current customers, or a sample of similar customers if their own sample is not large enough, and analyzes it statistically to identify those characteristics that relate to creditworthiness.  Then, each of these factors is assigned a weight based on how strong a predictor it is of who will likely be a good credit risk.  Each creditor may use its own credit scoring model, different scoring models for different types of credit, or a generic model developed by a credit scoring company.

      Under the Equal Credit Opportunity Act, a credit scoring system may not use certain characteristics like -- race, sex, marital status, national origin, or religion -- as factors.  However, mortgage providers, like all creditors are allowed to use age in a properly designed scoring system.  But any scoring system that includes age must give equal treatment to elderly applicants.

      Factors that can damage your FICO credit score include late payments, absence of credit references, and unfavorable credit card use.

      According to many knowledgable industry sources, your FICO credit score is made up of five major components:

Some Typical Credit Score Guidelines

FICO Scores 650 and Above

      In general, a FICO score of 650 or above indicates a very good credit history.  People with scores above 650 will usually find the loan process quick and easy, and will be able to obtain a loan at or close to the lowest rates available and be eligible for a down payment as low as 5%.

FICO Scores between 620 to 650

      FCO scores between 620 and 650 indicate basically good credit. (Average FICO scores fall into this range.) People with scores in this range have a good chance at a mortgage at a good rate, but may nned to provide the lender with some extra documentation and explanations.

FICO Scores between 550 and 620

      A FICO score below 620 will most likely prevent you from getting the best interest rate since you'll be considered a substantial credit risk.   This score alone, however, does not mean that a source of a mortgage can't be found if all of your other considerations are favorable.  People with FICO scores in this range will likely pay a penalty in terms of a higher down payment and/or a higher interest rate.  For some who find themselves in this situation, it can still be a good idea to go ahead and buy the home, make your payments on time, clean up your other credit risk exposures and then, in a couple years or so, go back and ask to refinance your mortgate at a more attractive interest rate.

FICO Scores below 550

      This scoring represent an overall poor credit history.   Understand that, at this credit rating, some lenders will simply refuse to give you a mortgage under any circumstances. If you do get a mortgage, part of the loan will be used to pay off other debts before any is applied to your home purchase, the interest rate will be quite high and you may be required to make a much higher than usual down payment (perhaps 30% or more of the purchase price).  If your FICO score is this low, you probably need to consider "cleaning up your credit act" before planning to buy a home.

     Keep in mind that these are only "general" guidelines"  Some lenders assign different grades or use different grade definitions based upon their own methods of evaluating your credit worthiness.

      Here's the bottom line on credit ratings.  If you want a home of your own, start today to think about everything you do, every purchase you make, and every bill you pay or let slide, in terms of what effect it may have on your credit rating.

      And remember to check your credit report once a year.  By some estimates, up to 50% of all credit reports contain serious errors that could impair your ability to get a mortgage.

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