Understanding Your Credit Rating

      Perhaps the most important factor in obtaining a good interest rate on your mortgage is your "credit history."  We'll try to help you here to understand your credit rating and the mortgage terms you can expect from a lender based upon your credit rating or "credit score".

      When you apply for a mortgage from a lender or broker, by far the most important factor is your credit.  In some cases, your ability to get a mortgage is determined entirely by your credit.  Generally, there are other factors but your credit rating is probably the single most critical factor that determines whether you'll get a mortgage loan at all and at what interest rate you will get the mortgage.  The better your credit rating and the better you manage your credit, the lower your mortgage interest rate will be.

Before You Start Looking for a Home

      Before you start looking for a home, take the time to order your credit report from all three major credit reporting agencies.  The three major credit reporting agencies are:

A General Guide to Credit Ratings

      First a definition.  Your "credit rating score" is generally expressed as a "FICO score."  FICO stands for Fair Isaac Credit Organization, a standardized way of expressing your credit worthiness.  It's a measure of the risk a lender is taking in providing you a loan.  Your credit risk is calculated from a credit report using a standardized formula.  

      To develop their specific credit scoring model, each mortgage provider selects a random sample of its past and current customers or a sample of similar customers if their own sample is not large enough.  Then they analyze that sample statistically to identify factors or characteristics that relate to creditworthiness.  Then, each of these factors is assigned a weight based on how strong a predictor it is of who will likely be a good credit risk.  Each creditor may use its own credit scoring model, different scoring models for different types of credit, or a generic model developed by a credit scoring company.

      Under the Equal Credit Opportunity Act, a credit scoring system may not use certain characteristics like -- race, sex, marital status, national origin, or religion -- as factors.  However, mortgage providers, like all creditors are allowed to use age in a properly designed scoring system.  But any scoring system that includes age must give equal treatment to elderly applicants.

      Factors that can damage your FICO credit score include late payments, absence of credit references, and unfavorable credit card use.

      As an example, according to www.credit-score-online.com, your FICO credit score is made up of five major components:

     You can learn more about how your FICO score is computed at www.credit-score-online.com.

Some Typical Credit Score Guidelines

FICO Scores 650 and Above

      In general, a FICO score of 650 or above indicates a very good credit history.  People with these scores will usually find the loan process quick and easy, and will have a good chance to obtain a loan at a relatively low rate of interest.  You will also be eligible for a down payment as low as 5% of the purchase price of the home.

FICO Scores between 620 to 650

      FCO scores between 620 and 650 indicate basically good credit. (Average FICO scores fall into this range.) People with scores in this range have a good chance at a mortgage at a good rate, but may have to provide additional documentation and explanations to the lender before the loan is approved.  People with this type of score will also be eligible for a down payment as low as 5% of the purchase price of the home.

FICO Scores between 550 and 620

      A FICO score below 620 will very likely prevent you from getting the best interest rate, as you will be considered a greater credit risk.  But it does not mean that mortgage funding can't be found with some penalty in terms of a higher required down payment and a higher interest rate.

FICO Scores below 550

      This scoring represents an overall poor credit history.   Understand that, at this credit rating, some lenders will simply refuse to provide you a mortgage under any circumstances. If you do get a mortgage, the interest rate will be quite high and you may be required to make a much higher than usual down payment (perhaps 30% or more of the purchase price).  The first use of the loaned funds will be to pay off, at closing, all current judgments and late payments before any money is available for your home mortgage.   On the other hand, if you can get a mortgage even at these disadvantageous conditions, you may be able to refinance your mortgage to a more attractive interest rate after you establish a year or more of "on-time" payments on your mortgage and any revolving or credit card debt.

     Keep in mind that these are only "general" guidelines"  Lenders assign different grades or use different grade definitions based upon their own methods of evaluating your credit worthiness.

      Here's the bottom line on credit ratings.  If you want a home of your own, start today to think about everything you do, every purchase you make, and every bill you pay or let slide, in terms of what effect it may have on your credit rating.

      And remember to check your credit report once a year.  By some estimates, up to 50% of all credit reports contain serious errors that could impair your ability to get a mortgage.