Your credit score may be one of the most important numbers in your life. It’s only three digits, but it packs a big punch. Based on your financial history, your score can impact the loans you qualify for, payment terms, rates, and so much more.
For some, a credit score can make or break their ability to purchase a home, take out a car loan, or borrow money to buy something else. In this article, we’ll cover all you need to know to understand your credit report, how your score impacts your loan eligibility, and rates and steps you can take to improve your credit.
It takes work, but a good credit score can be life-changing for your financial future, so let’s get started!
Understanding Your Credit Report
Your credit report is an overview of your personal credit. It determines the terms and rates of all types of loans, including mortgages, car loans, personal loans, credit cards, and more.
Many lenders can tell a lot about borrowers based on their credit history. They use that information to determine whether they are attractive candidates and whether they would like to offer a loan.
Key Components of Your Score
The good news is that your credit score is not composed of one single element but rather of various factors.
The five key components when calculating credit scores are:
- Payment History: Your payment history is a detailed record of how you pay your debts. It includes credit card payments, student loans, auto loans, installment loans, mortgages, and more. Are you making payments on time? Do you have a history of late monthly payments? Have you filed bankruptcy or have a foreclosure, lien, lawsuit, wage attachment, or other judgments attached? Late or missed payments are the most significant part of your total credit score – 35 percent! So it’s critical you make timely payments.
- Credit Utilization: Your credit utilization is the amount you owe on your accounts compared to the total available credit. Think of it as your total balances vs. credit limits. Typically, your accounts should hover around 30 percent of the total limit if you carry balances. Cards that are maxed out or high can negatively impact your score. Your credit utilization shows how much you are in debt and if you can handle a new loan. It makes up 30 percent of your total credit score.
- Length of Credit History: Your credit history length is the amount of time you have had any type of credit. The longer your history, the more it shows lenders you are responsible. They can better see your pattern of paying on time, demonstrating you are a less risky borrower. It makes up 15 percent of your total credit score.
- Types of Credit: The kind of credit represents your mix of credit accounts. Generally speaking, most lenders like to see a credit mix, including credit cards, personal loans, retail accounts, installment loans, and mortgages. It demonstrates various lenders have extended you credit, which is another indicator of your responsibility. Your credit types make up 10 percent of your total credit score.
- Recent credit inquiries: A recent credit inquiry is known as a hard inquiry on your credit report. This indicates you are getting ready to take on more debt, and if you take out a lot of new credit quickly, it shows increased risk. Keep in mind if you are shopping around for rates, all inquiries in a 14-day period will be considered the same hit. This does not apply to multiple credit card openings during the same period. They stay on your credit reports for two years but only impact your score for one. Your recent credit inquiries make up 10 percent of your total credit score.
A good score can make getting loans and other lines of credit easier, so it’s critical to pay close attention to yours and make adjustments where you can. There are different credit scoring models, and the various credit bureaus may have slightly different credit scores based on their criteria.
Where to Get Your Credit Score
You can get your credit scores from many different sources, including free resources and paid credit reporting agencies, to get an idea of your current situation.
- Free resources: Credit card issuers and many financial websites allow you to check your credit report for free. The U.S. government also provides a free credit report annually that includes your score from all three credit bureaus.
- Paid resources: You can pay to get your score from credit reporting agencies, including Equifax, TransUnion, and Experian. Other companies also offer this service for a fee.
Remember that the score you see as a consumer may not be the score your lender sees. There are different types of scores, so if you want to know what impacts your loan potential, you’ll want to consult your mortgage lender.
Impact of Credit Score on Loan Eligibility
Your credit score plays a big part in the types of loans you can get and the rates and terms of your loan. Let’s review some different ways it can affect your loan eligibility.
Minimum Score Requirements
Typically, you’ll need a score of 500 or higher to qualify for a mortgage loan, though lenders often have different minimum requirements for various loan types.
Generally, you’ll want to consider the minimum score requirements below.
- Federal Housing Administration (FHA) home loans: 500 if you put 10 percent down or 580 if you put 3.5 percent down. These are best for those with low credit, but not all borrowers are eligible.
- US Department of Agriculture (USDA) loans: 580, though it varies by lender. There is no set minimum credit score.
- Veterans Administration (VA) loans: 620, though it varies by lender. There is no set minimum credit score, though not all borrowers are eligible.
- Conventional loans: 620, though it varies by lender.
- Personal loans: 580, though it varies by lender, personal loan amount, and more.
If you want the best rates, aim for a credit score of 700 or higher. Different scoring models are used, but they can help you get the best start.
Overall Credit History
Even if you meet the minimum credit score requirements, you may not be approved for a loan.
Instead, lenders look at your full history, including your debt-to-income ratio, monthly payment track record, the average age of your accounts, the length of credit history, and more. All of these factors impact the likelihood of your approval and carry varying weights based on the scoring models.
Derogatory Marks
If you have any derogatory marks on your history, lenders take that into account. Negative records like late payments, debt collections, and bankruptcies significantly lower credit scores.
They also indicate you are a risk, and there’s a higher chance you may default on your loan. Reputable lenders do not want to take that risk and may opt out of extending an offer.
How Credit Scores Impact Interest Rates
In addition to your overall loan eligibility, your credit score impacts your interest rates in various ways.
Risk-Based Pricing
All debt is risky, and lenders assess various factors when determining who to lend money to. They want to be paid back with interest, so they do what they can to make it happen.
Higher credit scores imply a lower risk. Therefore, the lower the risk, the better the interest rate you will get. You get a lower interest rate with higher credit scores, meaning you pay less in interest over time.
Your Credit Score Isn’t the Only Factor
Various factors will determine your interest rate. Yes, your credit score is a part of that. Still, lenders also look at your income, debt-to-income ratio, loan-to-value ratio, on-time payments, credit limits, credit mix, and other personal financial health indicators.
Additionally, lenders consider the state of the economy and other various market factors when setting the loan. These factors fluctuate over time, and you cannot control them.
Spend your time controlling what you can about your scores, including having a positive payment history, low revolving credit, and more. These can help provide additional insights for lenders trying to assess your risk.
Improving Your Credit Score
Thankfully, there are steps you can take to proactively improve your credit score if you hope to get a loan soon.
Consistent On-Time Payments
Making timely payments is the most important factor in improving your credit score. There is often a grace period for missed payments, so if you are a few days late, it may not be reflected on your credit reports.
However, your score can be significantly lower once the credit or loan issuer reports that you missed a payment. Even one late payment can make a difference. It becomes reflected in your overall credit history, and lenders may worry if you will make their payments on time.
Lowering Credit Utilization
If you can, you want to pay down your balances. You should aim to get your overall credit utilization under 30 percent to be most attractive to lenders.
Some may opt for balance transfers to help with debt consolidation; however, pay attention to the total balance. You should not have cards that are nearly maxed out to the credit limit, as this has a negative impact on your overall credit score.
Avoid Unnecessary Credit Inquiries
If you know you want a loan, avoid unnecessary credit inquiries. Don’t take out new credit or make large purchases, even if you’re going to diversify your credit mix. They decrease your credit score and demonstrate that you may be less attractive as a mortgage lender candidate.
Multiple credit inquiries show you’re trying to get more credit in a short amount of time, which may mean there is something wrong. You may even need to restart the loan process if you get a new loan or take on additional debt during your mortgage process.
Conclusion
Your credit score is important, and it’s just one piece of the puzzle when it comes to lenders assessing your risk when it comes to loan eligibility and rates. While there are minimum credit score requirements for most loans, the higher your score, the better rates you will get, making them more affordable.
At Arnaiz Mortgage, we can help you get started with the loan process, exploring your credit history to see what you qualify for and how we can help you get the loan you need. This includes mortgages, personal loans, and other types of funding to help you with your individual situation.
What are you waiting for? Contact us at (623) 806-4645 or tarnaiz@arnaizmortgage.com today to start filling out your loan application.