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The Impact Your Credit Score Can Have On Buying A New Home
What Is A Credit Score?
A credit score is a numerical expression that can range from 300 to 850 and is based on a level analysis of a person's credit files, to represent the creditworthiness of an individual. A credit score is primarily based on a credit report, information typically sourced from credit bureaus, and significantly impacts the terms of your loans and often dictates whether you can afford these loans. Credit scores are used in evaluating a range of loans such as personal loans, car loans, and home mortgages, so credit scores are equally important for both renters and homeowners.
Your credit score determines how much you can borrow and the length of your repayment. The higher the credit score, the better. A high credit score lowers the rate on your loan, as well as your monthly payment.
Because a credit score is such a critical determinant of loan security at a low rate, it is crucial to understand what factors determine your credit score. Having this knowledge and understanding will help you plan for and work towards improving your credit score as you prepare to begin house hunting. We will spend the next two weeks discussing the topic of credit score and the impact yours can have on your real estate journey. This week, we will look at several ways your FICO credit score is affected.
Factors Affecting FICO Credit Score
FICO credit scores can range from 300 to 850, with the higher number being the better score and the lower figure presenting a higher risk for the desired loan. When taking out a loan, the lending bank has to assess the possibility of repayment and then determine the risk for the loan. Factors affecting your credit scores are credit card debt, student loan debt, payment history, bankruptcy, and foreclosure. Personal and demographic factors such as age, race, address, marital status, income, and employment do not affect your credit score. When your credit score is run, banks often use Equifax, Experian, and Transunion. From the three scores, your score is determined by the middle number of those three.
Data from your credit report goes into the five major categories listed above. These make up your FICO score. Each of these is discussed more in-depth below.
Factor # 1: Payment History (35%)
This is the biggest factor affecting your credit score. Your payment history is made up by your account payment information, This includes any and all delinquencies and public records and shows lenders your ability to make payments on time.
Factor # 2: Amounts Owed (30%)
This is exactly what it sounds like. "Amounts Owed" shows lenders how much you owe on your accounts. When looking at this, the amount of available credit you are using on revolving accounts is heavily weighted.
Factor # 3: Length of Credit History (15%)
How long ago did you open your accounts? This is another contributing factor when your credit score is run.
Factor # 4: Types of Credit Used (10%)
Another thing considered is the types of credit you have used. This is the mix of accounts you have, such as revolving and installment. It would include credit card debt as well as student loans and mortgage payments.
Factor # 5: New Credit (5%)
This includes any pursuit of new credit you have made such as credit inquiries and the number of recently opened accounts you have. This is comprised of both secured and unsecured credit cards.
This chart from NAR Realtor is a great tool to help you visualize the breakdown of your credit score.
One Final Word: Loan-Level Price Adjustments
Loan-Level Price Adjustments (LLPAs) are risk-based pricing adjustments. These vary based on a variety of factors including, but not limited to, credit score, loan-to-value ratio, and type of product. These adjustments are upfront charges. Why does this matter when discussing credit score? When assessing these charges, a higher credit score will mean lower percentage of payment. In contrast, a higher loan-to-value will increase the percentage of payment. The Mortgage Calculator breaks this down in more detail, saying this:
"Simply put, LLPAs are added charges for certain risk factors on a mortgage. They are high loan-to-value (LTV), low credit scores, cash out, investment property, etc. They are calculated and assessed as a percentage of the loan amount. For example, if the loan amount is $100,000 and the total LLPAs equals 0.25%, the charge would equal $250.” – The Mortgage Calculator
Check out the chart below for an overview of upfront LLPAs from Fannie Mae.
Conclusion
Today, we took a deep-dive into the world of credit scores and hopefully brought some clarity and understanding on this often-confusing topic. We hope you were able to learn more abou the importance of credit score in securing a loan for a future home purchase. Next week, we will walk you through how to improve your credit score.
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