How Credit Affects Mortgages

Credit is tied to most big financial decisions you will make in your life. From things as little as opening up a store card at the mall to buying your first home, your credit score is going to play a factor.

When it comes to mortgages, lenders take your credit score, particularly your FICO score, into consideration in determining the interest rate that you will likely be stuck with for years.

How is your credit score determined and what can you do to use it to get a better rate on your mortgage? We’ll cover all of that and more in this article.

Deciphering credit scores

Most major lenders assign your credit score based on the information provided by three national credit bureaus: Equifax, Experian, and TransUnion. These companies report your credit history to FICO, who give you a score from 300 to 850 (850 being the best your score can get).

When applying for a mortgage (or attempting to be pre-approved for a home loan), the lender you choose will weight several aspects to determine if they will lend money to you and under what terms they will lend you the money. Among these are your employment status, current salary, your savings and assets, and your credit score.

Lenders use this data to attempt to determine how likely you are to pay off your debt. To be considered a “safe” person to lend money to it will require a combination of things, including good credit.

What is good credit? Credit scores are based on five components:

  • 35%: your payment history
  • 30%: your debt amount
  • 15%: length of your credit history
  • 10%: types of credit you have used
  • 10%: recent credit inquiries (such as taking out new loans or opening new credit cards)

As you can see, paying your bills and loans on time each month is the key factor in determining your credit score. Also important, however, is keeping your total amount of debt low.

Most aspects of your credit score are in your control. Only 10% of your score is determined by the length of your credit history (i.e., when you opened your first card or took out your first loan).

To build your credit score, you’ll need to focus on lowering your balances, making on-time payments, and giving yourself time to diversify your credit.

What does this mean for taking out mortgages?

A higher credit score will get you a lower interest rate. By the time you pay off your mortgage, just a hundred points on your credit score could save you thousands on your mortgage, and that’s not including the money you might save by getting lower interest rates on other loans as well.

If you would like to buy a home within the next few years, take this time to focus on building your credit score:

  • If you have high balances, do your best to lower them
  • If you have a tendency to miss payments, set recurring reminders in your phone to make sure you pay on time
  • If you don’t have diverse credit, it could be a good time to take out a loan or open your first credit card

When it comes time to apply for a mortgage, you’ll thank yourself for focusing more on your credit score.

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Mortgage Know How

When it comes to figuring out mortgages many people use the phrase, “it’s all Greek to me” but figuring out how mortgages work is actually quite simple.

First, a mortgage is a loan from a lender to a borrower to buy a piece of real property (a fancy way to say house, land, etc). The interest on the mortgage is the percentage of money the borrower agrees to pay the lender each year, in return for lending the money.

Here is where it gets complicated, the lender wants to loan to be affordable for the borrower so they spread the interest out over time. This is called amortization. Amortization is the amount of money that goes toward principal (the amount of the loan) and interest. This amount changes over time because the interest owed is spread over time.

There is a booklet put out by the U.S. Department of Housing and Urban Development that explains the mortgage and interest process. You can find the booklet here.

Now often your payment is more than just the principal and interest. A monthly mortgage payment is often called a PITI payment. No, not pity even though you might need pity when looking at your loan statement. PITI stands for:

Principal — the loan balance

Interest — interest owed on that balance

Real estate Taxes — taxes assessed by different government agencies to pay for school construction, fire department service, etc.

Property Insurance — insurance coverage against theft, fire, hurricanes and other disasters

There may also be other fees depending on the kind of mortgage you have. Your monthly payment may also include private mortgage insurance (PMI).

Remember there is a lot to know about mortgages beyond the rate so be sure to talk to a mortgage professional to make sure you fully understand your payment options.