Credit Score Guide: Fix Your FICO Score®

The government-sponsored enterprises, The Federal National Mortgage Association (Fannie Mae) and The Federal Home Loan Mortgage Corporation (Freddie Mac) require a particular minimum FICO Score. However, your lender ultimately decides on whether to extend you a mortgage. Generally, lenders and co-op boards look for higher scores.

Unless you are a cash buyer, obtaining a mortgage is a vital part of the home buying process. Therefore, we think it behooves the majority of buyers to understand this arcane topic.

What Credit Score Should You have Before Buying a Home?

Fannie Mae and Freddie Mac both require a minimum 620 FICO Score. You can have as low as a 580 FICO Score for an FHA Loan, which is insured by the Federal Housing Administration, providing you have a minimum 3.5% down payment, or a 500 FICO score if you can put down 10% of the purchase price.

If you are eligible for a VA loan, there is no minimum required score.

What the score means

There are three national credit bureaus, Equifax, Experian, and TransUnion. Each could very well have a different FICO score for you, however. The Fair Isaac Corporation had provided several explanations for the variation, including different time periods when the score request was made, varying information reported to the bureaus, and lenders reporting information to the bureaus at various times.

The scores range from 300 to 850. A bad credit score is 300 to 629 while a score of 630 to 689 indicates fair or average credit. Lenders consider your credit good range if the score is in the 690 to 719 range. If your score is at least 720, you have excellent credit.

Since there are three scores, lenders typically use the middle score. Hopefully, there is not too much variation, though.

One person has bad credit

If you are buying a house with someone that has poor credit, and his/her credit score indicates this, there are other options you can pursue. You can apply for a mortgage by yourself, providing you can get approved. Remember, there are other items that lenders look at, such as income, notably your debt to income ratio, and employment history.

There are legal ramifications that you should also consider. You are the one financially responsible for the mortgage. However, this does not affect the property’s ownership, and you can still hold the title in two names, regardless. If you go down this route, this means he/she has a financial interest but does not have a corresponding financial obligation.

What is a FICO Credit Score?

Many people go shopping for a mortgage blindly, without fully understanding the implications of their credit score and the impact on the interest rate and other term lenders are willing to offer. We will shed light on the factors that go into your score, items that will impact it, and why it is important to check for errors.

This may sound dull but bear with us. The knowledge we are imparting could save you a lot of money.

What is FICO?

This is the most widely used credit score. The name is derived from the fact that it was created in 1989 by a company that was called the Fair Isaac Corporation, hence FICO. It is used by approximately 90% of the top lenders in the country to assist in making credit decisions.

FICO scores range from 300 to 850. Your credit risk to the lender is lower the higher the score. In other words, the number sums up several factors to evaluate your riskiness from a lender’s point of view. You must have enough information, particularly recent data, for the credit bureaus to calculate a score. This typically means having at least one account open at least six months.

There are three major credit bureaus (Equifax, TransUnion, and Experian). FICO scores are determined based on the information obtained from these companies. Therefore, it is not unusual to have slightly different scores. For instance, the notification of a late payment may vary or miss an account. If there is a large difference, this warrants further investigation. While it may be legitimate, it likely means the agencies have different information. It is also important to realize that your credit score will change over time.

We will discuss the various information that goes into determining your score.

What does this mean for my rate?

If you have a score above 760, this is excellent. If it is above this threshold likely won’t get you better terms. However, if you are in the 500 range, your mortgage rate could be about 4% higher. It is essential to keep in mind that each lender will have its own rules. The difference on a $500,000 mortgage is over $1,300 a month assuming a 4.5% rate at the low end for a 30-year mortgage.

Importance of Credit Scores

Credit scores are important, and a low score will cause lenders to charge you a higher interest rate. If it is very low, you may not get a loan altogether. This was particularly true during the financial crisis when lending became very tight.

However, it is not the sole basis for making a lending decision. Nonetheless, obtaining your credit score to check for accuracy, particularly in this era of fraud, is very important, and not just if you are shopping for a mortgage. Under the Fair and Accurate Credit Transactions Act (FACT, each legal U.S. resident is entitled to a free copy of his or her credit report from each reporting agency once every 12 months.

What Goes Into a Credit Score?

The exact formula for calculating credit scores is kept under wraps. However, FICO has disclosed the various components and weights.

The largest portion, at 35% is payment history. Various items such as bankruptcy, liens, charge-offs, foreclosures, and late payments can have a significantly negative impact on your score. The second largest component (30%) is a debt burden. There are some different metrics, including debt to limit, the number of accounts with balances, and the amount owed on various types of accounts. In other words, it is a measure of credit utilization. If you max out your credit cards, your score will be lower. However, if you use less than 10%, that is a major plus. This is followed by the length of credit history (15%). The longer you have had credit, the higher your score. If you are new to using credit, your credits score will be lower.

The next two components are types of credit used and recent searches for credit, at 10% each. There is a benefit to having a history of different types of credit, such as mortgage and revolving (e.g., credit card). On the other hand, many credit inquiries, particularly within a short period, will harm your credit score. However, this is misunderstood by many. Only “hard” inquiries, such as when consumers apply for a credit card, loan, or mortgage, count against your score. Therefore, checking your score for errors or employment, will not lower it. Furthermore, if you are shopping around for a mortgage over a short period, your score will not meaningfully decrease since it is considered only one inquiry.

Components of your credit score

Figuring out your budget is one thing, but you’ll also need to get your bearings when it comes to your credit situation. Credit scores range from 300 – 850, and lenders require a score of at least 620 to approve a mortgage. To qualify for the best interest rate available, you will need a credit score of no less than 720. Several factors affect your credit rating:

• Your payment history: Do you make your monthly payments by the due date every month? A late payment can be almost as damaging as no payment at all.
• Your overall debt burden: High balances on multiple accounts tell lenders you may be overextended.
• The length of time you’ve had credit: A long history of prompt payments and paid off accounts improves your score.
• Your available credit: Many open accounts with low balances and lots of available credit are a red flag for lenders, signaling a risk for future credit problems.
• The types of credit accounts you have: Lenders prefer to see both secured (a car loan, for example) and unsecured (credit and charge cards) accounts; it’s a sign of financial responsibility.

How to Improve Your Credit Before apply

So, your credit has seen better days. Good news—it’s not the end of the world. While you may need to jump through hoops to even rent an apartment right now, you can bring your credit score up to eventually qualify for home-ownership. Start working on fixing your credit today.

Fortunately, there are also some things you can do to build your credit. You’ll get the best mortgage terms with a high credit score and a low debt-to-income ratio. Take steps now to boost your score before you see a lender.

Fix my credit to do list

1. Request a credit report from the three major credit bureaus (Equifax, Experian, and TransUnion), and check them carefully for errors. If you do spot a mistake, make sure it’s corrected with all three credit agencies.
2. Never make the minimum monthly payment on your credit card bills. It’s best to pay them in full each month, but if that’s not possible, pay as much as you can afford. Keep in mind that balance transfers can lower your overall credit score.
3. If you’ve had credit problems, wait at least a year before you apply for a loan. Lenders are more favorable the more time has elapsed since your last late payments.
4. It’s best not to open any loans or credit accounts in the months immediately before you apply for your mortgage. High levels of available credit can lower your credit score.
5. Once you’ve applied for a mortgage, freeze your spending until you close on your home. Don’t apply for any new credit cards or loans, and don’t make any significant purchases on existing cards.
6. Target two or three favorite mortgage lenders and apply to them all at the same time. Too many credit bureau inquiries lower your credit score, but several inquiries in a short period by a single type of lender will typically count as only one inquiry.
7. Stay away from finance companies. In addition to the high interest rates, most lenders view finance company accounts as evidence of bad money management.

When Your Credit Needs an Intervention

If you’re looking to buy a home in the future, fixing your credit score is vital. The recession of the late ’00s is still fresh in the minds of lenders, making home loan qualification regulations tight. For example, these days, you’ll need at least a 580 even to be considered for an FHA home loan.

The great thing about FICO scores is that they only go up and down according to an algorithm. These numbers aren’t biased. They don’t care who you are or where you come from. They only rate your financial capacity based on what you do. So, what can you do to bring up your credit score for home ownership?

Create a Good Payment History

Did you know that your payment history makes up roughly 35 percent of your credit score? Unpaid bills like past-due car payments are often submitted to credit reporting agencies. If you have anything like this on your record, you’ll need to remove it and replace it with a squeaky-clean record of fully paid bills.

Having no credit can be just as bad as having a low FICO score. With no history to go by, lenders may also be wary of trusting you with a home loan. If you have no credit, start making a paper trail for a good payment history, like taking over a phone bill. This will help set the foundation for a good score in the future.

Keep Your Balances Low

Not only should you shoot for a good payment history, but you should also keep your credit card balances low. Just because you have an $8,000 limit on your Visa card, it doesn’t mean it’s okay to make large purchases you can’t pay off on time. Credit reporting agencies see this kind of behavior as risky, which can lower your FICO score.

Remove Bad Credit Reports

Never underestimate the power of negotiation. Creditors don’t like unpaid bills just as much as you don’t want being bothered about them. When you call and present a “pay for delete offer,” you have a chance to get your lousy behavior removed after you pay off the debt. Many creditors will be happy to remove your nonpayment records in exchange for receiving the full payments. If you’re short on cash, negotiating installment payments over time is also often doable.

On a side note, you might have inaccurate bad reports. In this case, file a dispute letter to get the record removed.

Find and address credit card errors

In some cases, it’s not your fault if your credit score is low. Creditors sometimes make mistakes in their reports, at least one in four according to the Federal Trade Commission. Before doing anything else, request a report from each of the three nationwide credit reporting companies (Equifax, Experian, TransUnion) at Annual Credit Report. By law, you’re entitled to one free report a year. If you find anything unusual – say, a falsely reported late payment or unpaid bill – the report should tell you where to send the dispute. Once the error is corrected, you should see an immediate boost in your credit score.

Have activity on your credit report every month

Having no credit history is just as bad as having a low FICO score. With 35% of your score based on payment history, it is vital that you have a paper trail. The cheapest and easiest way to build and maintain your score is through the use of a credit card. This doesn’t mean you need to make large purchases on a regular basis. Just one or two purchases by card a month (it can be as little as a loaf of bread). Then make sure you pay the statement balance in full and on time every month.

Keep your utilization low

Your credit score depends not just on what you owe but on what you owe compared with your credit limit, a ratio known as credit utilization. For example, if you have a $4,000 balance on your card with an $8,000 limit, your credit utilization is 50 percent. There are a few theories on what the best credit utilization level is, but most agree that it should be no more than 30 percent. A card that is continually being maxed out is a red light for either a lack of control or financial hardship.

Get your bills current

You typically have 30 days to make a payment so If you’re running late on one try to get it paid ASAP. Even if you’ve already passed that mark the sooner, you pay it; the less damage is done. If you’ve had a bad run of missing payments in previous months, you can fix the damage by immediately switching to paying all bills on time. After 2-3 months you should see an improvement in your credit score.

Become an authorized user

Do you know someone you trust completely and is good at managing money? If so, and they’re willing to let you become an authorized user, then their account will show up on your credit report. As a result, your credit score gets a boost from their on-time payments and (hopefully great) credit utilization rate. Just make sure you choose someone who does pay their bills on time and keeps a low debt. Bad credit history will show up just as much as good.

Remove bad credit reports

As with a lot of things, there’s always room for negotiation. Creditors don’t like unpaid bills anymore then you do. You have the option of getting your lousy behavior removed from your credit report by presenting them with a “pay for delete offer” in exchange for making the full payments. If it’s not possible for you to make the total payments now, negotiating for installment payments in another option.

These strategies may be straightforward but keep in mind that ‘fast’ is a relative term. Rome wasn’t built in a day nor was it destroyed overnight. Give it a good 2-3 months before you start seeing results.

Get to Work

A good credit score paves the way to a bright future of home-ownership. Pay your bills on time, keep your credit card balances low (paying it off fully every time will also save you interest charges), and don’t open too many new credit lines, including credit cards.

By taking these steps as soon as possible, you are likely to see improvements in your credit score.

To learn more about how your credit score is calculated, visit MyFICO.com. You also can request a free credit report at AnnualCreditReport.com.