Know Your Credit Rating

When it comes to obtaining a mortgage at the best interest rate, your credit rating, also known as credit score, may be the single-most important piece of financial information. In fact, your credit rating goes a long way toward determining what interest rate you qualify for from your lender.

Your credit rating is a number that is determined from information in your credit report. Credit ratings range from 300 to 850, depending on the credit scoring agency. The higher the number, the better your credit rating. So, before you start house hunting and getting pre-approved for a home loan, it’s a great idea to first check your credit report and get your credit rating.

What is a credit report? What is a FICO score? Is a credit report the same as a FICO score? No – they are two different things, but they are related.

Your credit report is exactly as it sounds – it’s a report of your credit history. It contains all kinds of personal financial information such as your credit accounts (mortgage, auto, department store, etc.), listing when they were opened, their current balances, credit limit and whether they were paid on time; any outstanding taxes or liens against you; late civil or child support payments; court judgments (parking tickets, etc.) and any city, county, state and federal liens for unpaid taxes and bankruptcies.

Three major reporting bureaus (Equifax, TransUnion, and Experian) who furnish credit reports and they also furnish your credit rating or credit score. This rating or score can also be referred to as your FICO score. FICO stands for Fair Isaac Corporation, a company that was the first to create a credit score in the 1980s. Now simply known as FICO score, it is a number derived from your credit reports and is considered the standard. About 70 to 80 percent of mortgage lenders use the FICO score. Since there are three credit-reporting bureaus, you have three FICO scores.

Here’s what a FICO score is based on:

• Payment history (35% of score): Have you paid your bills on time?
• Amounts owed (30%): What is your overall debt?
• Length of credit history (15%): How long have you been borrowing money? Lenders like to see a long credit history.
• New credit (10%): Have you applied for new credit?
• Types of credit used (10%): Lenders like to see all kinds of credit types — bank cards, car loans, student loans and more.

The FICO scores range from 350 to 850, with an 850 as the Holy Grail of credit scores and 723 serving the median score in the U.S. You can expect good mortgage interest rates starting at the 720 level.

While you may not know your exact FICO score before you request it, you may have an idea where you stand. For instance, you’re probably in good credit standing if you’re receiving a lot of zero- percent credit card offers, or if you are being offered lines of credit for zero or very low interest rates.

Not everyone has to have reached the Holy Grail! Home buyers who pursue an FHA loan, one of the most common loan types for first-time purchasers, can usually secure a loan if their credit is 630 or higher.

If you are applying for a no-income-verification loan, whereby you forgo providing income documents to the lender because your income is not consistent or you are in a crunch for time, the lender will be looking for a minimum FICO score of 680 or higher. Banks don’t like to assume all the risk, so your good credit history is key, although other types of lenders may have more flexibility in determining your mortgage interest rate. In any case, credit reports are critical in these kinds of transactions, as lenders have tightened their standards since 2008.

The Federal Regulation

The Fair Credit Reporting Act (FCRA) requires each of the nationwide consumer reporting companies — Equifax, Experian and TransUnion — to provide you with a free copy of your credit report, at your request, once every 12 months. The Federal Trade Commission (FTC), the nation’s consumer protection agency, has prepared a brochure, Your Access to Free Credit Reports, explaining your rights under the FCRA and how to order a free annual credit report.

If your credit reports or FICO score make you want to hide under the covers, resist! You can take concrete steps to turn things around. Many financial experts suggest the same common sense strategies to turn your credit report around:

• Always pay your minimum balance on time: Let’s face it, credit card companies make handsome profits when their customers maintain a balance. Just make sure you send them their due each month.
• Try to reduce balances: Even throwing in an extra $20 to $50 each month will help reduce the overall debt, and paying extra looks good on your credit report.
• Don’t run up the entire balance: Having $100 left on a $10,000 line of credit doesn’t look so hot. Lenders look at the dollar amount of credit available to you and, from there, what percentage of that credit you have used. In other words, if you have a card with a $1,000 limit and you’ve spent $900 on that card, you’ve used 90 percent of your available credit; this looks a lot worse than having a balance of, say, $200 on the card.
• Throw away new credit card offers: Don’t apply for new cards and lines of credit right before you go home shopping. Banks will not turn a blind eye to numerous inquiries for new credit.

If bad credit continues to dog you, the FHA loan programs may be your ideal option. New lending standards instituted by the Federal Housing Administration in 2012 for its loan programs require new borrowers to have a minimum FICO score of 580 to qualify for the FHA’s 3.5 percent down payment program. New borrowers with less than a 580 FICO score will be required to put down at least 10 percent.