We previously discussed how to pre-qualify yourself for a mortgage loan, but as part of the pre-qualifying process you need to get a copy of your credit report. Knowing exactly what's on your credit report can help your loan application process go more smoothly. Whatever lender you choose, they will also pull your credit report as part of the application process, but you should pull a copy of it for yourself every year.
You can get a free copy of your credit report from annualcreditreport.com, or for a small fee you can get a copy of your credit report from a credit reporting agency like myfico.com. FinancialElite.com recommends that you get what is called a tri-merge credit score, which is a combination of all three credit reporting bureaus: Experian, Trans Union, and Equifax.
What is Credit Scoring?
Credit scoring is a statistical method used to predict the likelihood that a potential borrower will repay debt, such as a mortgage loan.
A credit score is based solely on information in a credit report:
- Previous credit performance
- Current level of indebtedness
- Amount of time credit has been in use
- Pursuit of new credit
- Types of credit available
Your credit score in NOT based on factors prohibited under the Equal Credit Opportunity Act (ECOA), such as race, gender, color, religion, national origin, and marital status. Excluded from the credit score formula are income, employment, and residence.
The FICO score is developed by the Fair Isaac Corporation and is the most common credit score used in mortgage lending. These are the five main components of determine your FICO credit score:
- Payment history accounts for 35 percent of your FICO score.
Are you late on paying your bills? How long ago did these late payments occur? How long were you delinquent on any of your bills at one time? What was your highest level of delinquency you had in the last year? How many months have gone by since the most recent negative item on your credit report (such as a judgement, lien, bankruptcy, etc.)? Generally, the worse off your credit performance, the worse the credit score. Recent bad credit has more of a negative impact on your score.
- Amounts Owed account for 30 percent of your FICO score.
How many loans and open credit cards do you have? What is ratio of your revolving debt to your total revolving limits available to you? What is the percentage outstanding on your installment loans? Generally, the higher the percentage of utilization of credit, the higher the risk. Do Not max out your credit cards!
- Length of credit history accounts for 15 percent of your FICO score.
How long ago did you establish credit? Usually, the longer you have had credit and have successfully paid your debts on time, the better the score. However, if you have fairly new
credit or only one or two traditional accounts, you can still obtain high scores too.
- New Credit accounts for 10 percent of your FICO score.
Are you applying for new sources of credit, like an additional credit card or auto loan? The credit score calculation will only take into account inquiries you initiated into account.
The score takes into account inquiries over a 12 month period. Any inquiries related to auto loans or mortgage loans that have taken place over the past 30 days are excluded. Also, any multiple inquiries for auto loans or mortgage loans that occur in any 14 day period are considered as a single inquiry.
There are types of inquiries that the score does not take into account. These are inquiries that you did not initiate yourself by applying for credit. For instance, banks mail promotions to consumers to whom they would like to issue a credit card. These types of inquiries appear on your report as PRM or promotional inquiries and do not affect your credit score.
- How you use your credit accounts for 10 percent of your FICO score.
How many different types of credit do you have? Bank issued Visa or MasterCards? Department store credit cards? Installment credit with which you used to purchase furniture? Usually, the types of credit you have available are not as important when determining a credit score as the previously mentioned categories.
How do I establish credit?
If you don't have an established credit history, whether it's good or bad, there is no time like the present to get one established. If you don't have an established credit history with traditional credit source such as, credit cards, auto loan, or student loan, it is always possible to establish one. You can establish a credit history by documenting your monthly rent payments, your utility payments (electric, gas, water, telephone service, cable television, insurance for your medical, auto, and life insurance).
How do I repair my bad credit?
From time to time you may be surprised you that your credit is not as clean as you might like. If you currently have credit problems you may not be able to buy a home until you get your credit cleaned up. If your payment problems are in the past, your recent payment history of payments being made on time may help your situation. It is law that your most derogatory credit information must be dropped from your credit report after seven years. A bankruptcy will remain on your credit for 10 years.
If you are behind on your bills you may want to consider contacting the National Foundation for Credit Counseling (NFCC). They can help you develop a plan for improving your credit. You can contact them at (800) 388-2227 or visit nfcc.org.
How do I correct wrong information on my credit report?
Every now and then there may be incorrect information on your credit report which may give a false impression of past credit issues that have been resolved.
To keep aware of what's happening with your credit, you should obtain a copy of your credit report every year. You never want to be declined for a mortgage because of a erroneous credit report. If you find incorrect information on your credit report, the credit reporting agnecy showing the incorrect information must include your explanation of the situation in future credit reports. Get into the habit of checking your credit report every year. If you haven't done so this year, do it now. After January 1, do it again.
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