As March is National Credit Education Month, it is an ideal time to learn more about how your credit plays a significant role in the mortgage process. For potential home buyers, it is essential to have a good understanding of how credit works and how it can affect your chances of obtaining a mortgage.
What is Credit?
Credit is the ability to borrow money or access goods or services with the understanding that you’ll pay later. Credit scores range from 300 to 850, and they are calculated based on your payment history, amount of debt, length of credit history, and other factors. A high credit score indicates that you have a good credit history, while a low credit score suggests that you have a history of late payments, defaults, or other financial problems. Credit is part of your financial power, and it helps you get the things that you need now, and pay them back later.
How is a Credit Score Calculated?
Credit scores are calculated using several factors, including payment history, credit utilization, credit mix, and length of credit history. Payment history accounts for 35% of your credit score, and it reflects your ability to make on-time payments. Credit utilization accounts for 30% of your credit score, and it reflects the amount of credit you use compared to your credit limit. Credit mix accounts for 10% of your credit score, and it reflects the variety of credit accounts you have, such as credit cards, auto loans, and mortgages. Length of credit history accounts for 15% of your credit score, and it reflects how long you have had credit accounts. The final 10% is based on the number of credit inquiries – which is basically a request to look at your credit file. There are two type of inquiries, a soft pull and hard pull. Lenders run hard checks when you officially apply for credit, which can cause your credit score to drop slightly. Soft checks on the other hand, are for things like pre-approvals, background checks, or when you are taking a peek at your own score, and they have no effect on your credit score.
How Does Credit Score Affect Mortgages?
Your credit score affects your ability to get approved for a mortgage, the loan amount you can borrow, and the interest rate you will pay. Lenders consider credit scores when determining the risk of lending money to a borrower. A high credit score is an indication that you are a low-risk borrower, and you are more likely to get approved for a mortgage. On the other hand, a low credit score is an indication that you are a high-risk borrower, and lenders may be hesitant to lend you money. But do not fear, there are plenty of things that you can start doing to improve your score and different loan programs have different requirements.
In addition to affecting your ability to get approved for a mortgage, your credit score also affects the loan amount you can borrow. Lenders use your credit score to determine your debt-to-income ratio (DTI), which is the percentage of your monthly income that goes towards paying debts. A high credit score indicates that you have a good DTI, and you can borrow a higher loan amount.
Also, your credit score affects the interest rate you will pay on your mortgage. A higher credit score translates to a lower interest rate, which can save you thousands of dollars over the life of the loan. Each individual situation will vary, so be sure to enlist the help of a mortgage broker to assess what the best thing to do in your situation will be.
As a potential homebuyer, it is essential to monitor your credit score regularly and take steps to improve it if necessary. This includes making on-time payments, keeping credit card balances low (under 30% is recommended), and avoiding new credit applications before applying for a mortgage. By understanding credit and its relationship to mortgages, you can take steps to ensure that you get the best mortgage terms possible. Of course, Acadia Lending Group is here to offer you assistance and is just a phone call away.