Many Americans have a basic understanding of credit – specifically the concept of “good” vs “bad” credit. But what makes it good or bad? And how can that affect buying your first home? Credit can seem like a complex and daunting obstacle, but Lennar is here to help. This article will break down what credit is, the factors that determine it, how it affects buying your first home and ways to improve your credit.
What is credit
In short, it is your reputation as a borrower. It’s a standardized way to express your history of managing your debt and making on-time payments. Your credit score is a number that represents your reliability to repay past debts. Here is a common range for the score:
- Excellent – 800-850
- Very Good – 740-799
- Good – 670-739
- Fair – 580-669
- Poor – 300-579
You can find this number by checking your credit report, which is created by the three major credit reporting agencies that gather your history and report your credit score. These bureaus are Equifax, Experian and TransUnion. They create a master document – a credit report – that includes open and closed accounts, account balances, credit limits, hard inquiries into your credit and your payment history.
So how does all of this affect your day-to-day life? The better your credit is, the more financial opportunities you’ll have to choose from. A higher score means you are more likely to be approved. This can also mean more favorable loan terms and higher incentive credit cards.
Five factors determine your credit score
The most widely used way to establish your credit score is the FICO® Score, ranging from 300 to 850 as shown above. These are the five factors that determine this score:
1. 35% payment history
This is your history of paying your credit accounts on time. Avoid making payments late to keep your credit score healthy.
2. 30% amounts owed
This is the total amount of debt that you owe. On top of paying down your loans over time, aim to use a low percentage of available credit.
3. 15% length of credit history
How long you’ve had a history of managing debt also matters. A longer history can lead to a higher score.
4. 10% credit mix
Having both revolving credit (like a credit card) and installment loans is beneficial to your score.
5. 10% new credit
Multiple hard inquiries at once can lower your score. Avoid making major purchases around the same time.
How credit affects buying a home
If you’re looking to buying your first home, paying special attention to your credit can go a long way. The credit score is a primary metric a lender will use to determine if you qualify for a mortgage. If you do quality, it will also influence the terms of the loan.
There are several benefits associated with a higher credit score when deciding on a mortgage. You qualify for more loan products, giving you the flexibility to choose what works best for you. You have access to more down payment assistance options. You can also receive lower interest rates on your mortgage.
A lower score means the lender is taking on a bigger risk by lending to you. If approved, borrowers with a lower credit score can expect to pay higher interest rates.
It may take a while to improve your score, so plan ahead. It’s a good idea to take these steps before you begin looking for your first home:
- Request a credit report from the three bureaus.
- Review your report for inaccuracies and areas of improvement.
- Avoid opening new lines of credit or making major purchases (like buying a car) during the mortgage process.
- Shop around for the best mortgage. All inquiries from mortgage companies within 30 days will count as just one hard inquiry on your credit report.
How to improve your credit score
Now you know the importance of the credit score, it’s time to take what you’ve learned and improve or maintain that number.
1. Make payments on time
Payment history is responsible for the largest percentage of your credit score. Late payments can stick around for up to 7 years. For ease of mind, set up auto-payments for bills to avoid missing by mistake.
2. Open a credit card
This adds to the mix of accounts listed on your credit report. Make sure not to spend more than you can pay back.
3. Improve your credit utilization
This is the ratio of your outstanding balance to overall available credit. Even if you pay off your balance in full each month, aim to use less than 30% of your limit before making a payment. To lower utilization, you can decrease your use of the card or increase your limit.
4. Resolve any inaccuracies
Errors that can bring down your score may include activity you do not recognize or that isn’t in your name, payments incorrectly reported as late or negative info that is too old to be included in the report.
5. Keep it up!
Every on-time payment builds your reputation as a reliable borrower.
As part of our mission to create the world’s simplest path to homeownership, we’re pleased to provide complimentary credit education through our HomeBuyer Solutions Group. This pairs customers with a Credit Specialist to bring them closer to securing their dream home.
