When looking to secure a home mortgage loan, your credit score must be up to par. While some loans are more flexible than others in terms of credit requirements, you still need to pay attention to what your current score is and how you can improve it, as it suggests your ability (or inability) to pay back the funds you receive from a mortgage lender.
The Fair Isaac Corporation (FICO®) created a well-known type of credit score, commonly reviewed by lenders when assessing a potential borrower’s qualifications. There are five key factors that impact this particular credit score, which ranges from 300 to 850, and borrowers should keep these in mind as they prepare to apply for a mortgage loan:
1. What Your Payment History Looks Like
As explained by myFICOTM, the consumer division of FICO, your payment history makes up 35 percent of your credit score. In fact, “The first thing any lender wants to know is something about your credit history. Namely, whether your credit payments have been made on time,” it states.
As a result, if you’re someone who tends to wait until the last minute to pay your credit card bills and they end up being late most of the time, your credit score will be affected—negatively. FICO will not only look at how late these payments usually are, but also the number of accounts you currently have and how much you owe each one.
However, it’s not just credit card payments FICO considers when looking at your payment history. Any credit cards you have for retail or department stores, as well as installment loans (i.e., car or student loans), are just a couple other accounts evaluated.
The reason your payment history plays such an important role in calculating your credit score is because it indicates how financially stable you are, which is something lenders want to know. If you’re struggling to pay back the money you already owe, it’s not likely you’ll be able to handle another loan.
2. The Amount of Money You Owe
As aforementioned, and also discussed by myFICO, “Part of the science of scoring is determining how much is too much for a given credit profile.” While not considered as much as your payment history, the amount of money you owe accounts for 30 percent of your credit score.
Still, just because you may have several other loans to pay off doesn’t necessarily mean you won’t be approved for a mortgage loan. It only becomes an issue in certain cases in which “a high percentage of a person's available credit is been used.” This is because it “can indicate that a person is overextended, and is more likely to make late or missed payments,” continues myFICO.
3. How Long You’ve Been Building Your Credit
The “length of your credit history” is another critical component of your credit score. While it doesn’t hold as much weight as the previous two points, it does constitute 15 percent of your credit score, as explained in a March 2018 blog post by myFICO.
“This number is calculated using your oldest and newest accounts divided by your total number of accounts,” the article explains.
The significance of your credit history length is actually connected to your payment history and the number of new accounts you have—another factor that we will get to later (see #5).
“For instance,” the post shares, “if you miss a credit card payment (or two), it could have more of an impact on your FICO® Score if you have a shorter credit history. On the other hand, if you have a very long history showing consistently on-time payments and miss a mortgage payment or open a new account, the damage to your score could be less.”
4. Different Types of Credit You Utilize
Although it only accounts for 10 percent of your credit score, myFICO points out that “your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans” are also considered.
“Having credit cards and installment loans with a good credit history will raise your FICO Scores. People with no credit cards tend to be viewed as a higher risk than people who have managed credit cards responsibly,” myFICO explains.
However, it’s important to remember that you shouldn’t just open accounts for the sake of opening accounts. It will end up negatively impacting your credit score if you have accounts that you do not actually use.
5. Number of New Accounts You Have
Also determining 10 percent of your credit score, the number of new accounts you have, or your “new credit,” is the last factor that impacts your credit score.
Remember, “research shows that opening several new credit accounts in a short period of time represents greater risk - especially for people who don't have a long credit history," as shared by myFICO.
It adds, “Your FICO Scores take into account several factors, including how you shop for credit.”
Further, when you open several new accounts in a short period of time, your average account age decreases, which could hurt your credit score. Your best bet would be to wait a certain amount of time in between opening new accounts, rather than doing it all at once.