Understanding Your Credit Report
Mortgage rates continue to hover at record lows. That’s good news for potential homebuyers, but it’s important to remember that the stronger your qualifications, the better interest rate you will be able to lock in. The first step is understanding your credit report and the credit score it assigns.
What’s a credit report?
A credit report is a document that provides a snapshot of how a person manages money. Lenders use this financial snapshot and a person’s credit score to predict what kind of risk he/she might be.
In the U.S., three major credit bureaus, Experian, Equifax and TransUnion, collect information from public records and companies with which a credit seeker does business. From that data, they create a credit report which includes:
- Name, current and previous addresses and Social Security number.
- A list of credit accounts, including reports from creditors.
- Public record information and information from collection agencies, including delinquent accounts, foreclosures, bankruptcies, wage attachments, lawsuits, liens and judgments.
- Credit inquiries from the past two years. For example, if a homebuyer has applied for a credit card or a bank loan, there will be a record of the credit card company or bank that has inquired about that person’s credit history.
Under federal law, you are entitled to receive a free credit report from each of the agencies every 12 months.
What’s a credit score?
Based on the information in the credit report, a person is assigned a credit score. This number reflects how likely he or she will repay a loan. Higher credit scores mean less risk, so a potential homebuyer can more easily borrow money at lower interest rates. Lower credit scores reflect higher risk and may mean a person will be offered higher interest rates or be denied credit altogether.
The most commonly used credit scores are provided by Fair Isaac Corporation and are known as FICO® scores. They range from 850 (the best) to 300 (the worst). Of course, lenders make their own determinations, but in most instances, 700 or above is generally considered to be a good score.
Each credit bureau uses its own formula when calculating a credit score, so you may have a different FICO score from each agency. However, since all the bureaus use a person’s credit report, the different FICO scores are usually similar.
What factors determine a credit score?
Five key items are considered when creating a credit score. They include:
- Payment history. Paying bills on time leads to a higher credit score. Late payments, delinquent or over limit accounts, bankruptcies and liens all can cause scores to dip or plummet.
- Total debt. This is the amount a person owes in comparison to his/her amount of available credit (or debt-to-credit ratio). High credit card balances can lower scores as they may reflect trouble making monthly payments. Conversely, if credit limits are higher and balances are low or are paid off consistently every month, a debt-to-credit ratio will be low, and the credit score should be higher.
- Length of credit history. Illustrates how long a person has used credit and how well or poorly they have taken care of finances.
- New credit accounts and inquiries. Shows new credit accounts and recent inquiries from companies to whom a person has applied for credit. Applying for too much credit can lower a score.
- Types of credit. Includes all credit accounts, from installment loans and credit cards to mortgages and other types of credit.
How do I find out my credit score?
Visit annualcreditreport.com to order your reports. Or, if you have applied for a credit card, and it was denied, the credit bureau that reported your score must offer a free report to you.
Every year, it’s a great idea to review your credit report. If you find any errors, report them to the credit bureaus and the creditor where it occurred to get them corrected.
How can you get a good score?
In short, pay your bills on time, and don’t run up your debt. Aim to keep debt payments (credit cards and loans) to less than 20 percent of your income.
Searching for a new home? Our New Home Specialists can walk you through the homebuying process from start to finish.