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Like it or not, your credit score is one of the most important numbers in your life, ranking up there with your Social Security number, date of birth and wedding anniversary.
This three-digit number is your financial report card, except there's no getting rid of it after college. Your credit score shows lenders just how trustworthy you are when it comes to managing your finances, and it can either save or cost you thousands of dollars throughout your life. If you're in the dark about how significantly this number can impact you and the details behind your score, here's an overview of what you need to know before hitting the mortgage application.
HOW YOUR CREDIT SCORE IS CALCULATED
Your FICO credit score is comprised of five elements; according to the Fair, Isaac Corp., 35 percent of your score is attributed to how you pay your bills. Points are added for paying on time and deducted for late or missing payments. This is a big portion of your score, so if you're not paying bills on time, it's best to get that under control pronto.
Thirty percent of your score is based on your credit utilization ratio. Translation: How much money do you owe as a portion of the amount of credit available to you? The lower this ratio, the better. Fifteen percent is based on the length of your credit history. When did you open your first account (and is it still open)? Ten percent of your score goes to the type of credit you have. Think revolving credit (such as credit cards) and installment credit (such as car loans and mortgages). New credit applications impact the last 10 percent. How often and for what types of credit are you applying?
WHERE TO FIND YOUR CREDIT SCORE AND HOW TO ACCESS IT
Some websites you can use to find your score are annualcreditreport.com, which will give you one free report a year, or creditkarma.com, which will provide you with free access to your score upon signing up for an account. Some banks even offer free access to your credit score when you sign up for an account. Once you have copies of your report and score, immediately look for fraudulent or erroneous information. If you find anything, immediately contact both the credit reporting agency and the company portraying inaccurate information to determine the next steps.
WHAT IS CONSIDERED A GOOD CREDIT SCORE?
What is considered a good credit score? Your score can range from about 300 to 850. You'll find a variety of breakdowns on what's considered "good" compared to "excellent" versus "poor," but in general, you'll want to aim for a score of 740 and higher, which is the "excellent" range. The higher your credit score, the more creditworthy you appear to lenders (meaning they can rely on you to pay your debts and pay them on time), which translates into lower interest rates and more money saved when taking out a loan.
What will help you achieve a good credit score? Keeping your credit utilization at or below 30 percent on your credit cards or paying them in full each month. This means using less than 30 percent of the credit made available to you. Be sure to make payments on time consistently for your utilities, rent and credit and installment loans. Having a positive credit history of seven-plus years and a low debt-to-income ratio also will work in your favor. All of this will show lenders that you are consistent and able to keep up with payments. So how do you determine your debt-to-income ratio? Divide your monthly credit payments by your monthly gross income. So what is a good debt-to-income ratio? Lenders typically like 28 to 36 percent and definitely no higher than 43 percent.
So, what can damage your credit score? If you carry large balances on your credit cards from month to month. Or you make late or miss payments, especially on credit cards and installment loans. Also, having a short or sketchy credit history or having a high debt-to-income ratio means you have overextended yourself in credit debt. All this will take a chunk out of your overall credit score. Lenders like to see positive consistency when looking at creditworthiness.
A GOOD CREDIT SCORE CAN SAVE YOU MONEY
Can you save money by having a good credit score? The answer is yes. Those with good or excellent credit scores get lower interest rates on loans, which equals lower payments. So, what is an example of an interest rate you can get with good or excellent credit? For instance, for a $200,000, 30-year fixed-rate loan, you may get an interest rate of 3.75 percent, depending on the market. However, for those with not-so-good credit the difference (depending on the market) can mean a $200,000, 30-year fixed-rate loan at 5.5 percent. That's a 1.75 percent increase. How does this all translate as far as money paid? On the loan at 3.75 percent, the interest over the life of the loan will come to about $133,443. For the loan at 5.5 percent, the interest over the life of the loan will be about $208,808. The difference between the two is about $75,000 over the life of the loan. That's money that could have gone to other goals and needs.
To recap, having a solid credit score is one of the most financially savvy tools you can have on hand when it comes to buying a home. Your credit score will bring you confidence, peace of mind and more money saved via low-interest rates when managed wisely. Conversely, when mismanaged or not cared for at all, your credit score can delay your success in meeting financial goals and result in additional funds and resources spent correcting past mistakes.
Information in this article was provided by the Ohio Realtors Association.