Ever wonder how a mortgage company decides whether to approve your mortgage application? For years, mortgage lenders have been using a credit scoring systems to determine if you’d be a good risk to lend the money to finance your real estate purchase.
A higher credit score is interpreted that you are less of a risk, which, in turn, means you are more likely to get your mortgage application approved — or pay a lower interest rate.
What is credit scoring?
Credit scoring helps to determine whether or not to give you credit. It also may be used to help decide the interest rate you will pay for the loan.
Information about you and your credit experiences, such as your bill-paying history, the number and type of accounts you have, whether you pay your bills by the date they’re due, collection actions, outstanding debt, and the age of your accounts, is collected from your credit report. Using a statistical program, creditors compare this information to the loan repayment history of consumers with similar profiles. For example, a credit scoring system awards points for each factor that helps predict who is most likely to repay a debt. A total number of points — a credit score — helps predict how creditworthy you are: how likely it is that you will repay a loan and make the payments when they’re due.
Obtaining your credit reports
Your credit report influences many credit scoring systems. That’s why it is important that your credit report is accurate. Federal law gives you the right to get a free copy of your credit reports from each of the three national credit reporting companies once every 12 months. The Fair Credit Reporting Act also gives you the right to get your credit score from the national credit reporting companies.
To order your free annual credit report from one or all of the national credit reporting companies, visit www.annualcreditreport.com, call toll-free 877322-8228.
What factors impact a credit score?
Credit scoring systems are complex. If one scoring factor changes, your total score may change.
Scoring models usually consider the following types of information in your credit report to help compute your credit score:
- Do you pay your bills on time? You can count on payment history to be a significant factor. If your credit report indicates that you often pay your bills late, had an account referred to collections, or declared bankruptcy, it is likely to affect your score negatively.
- Have you maxed out your existing credit? Many scoring systems evaluate the amount of debt you have compared to your credit limits. If the amount you owe is close to your credit limit, it’s likely to have a negative effect on your score.
- How long have you had credit? Generally, scoring systems consider your credit history. A shorter credit history may negatively affect your score, but factors like timely payments and low balances can offset that.
- Have you recently applied for new credit? Many scoring systems consider whether you have recently applied for credit by looking at “inquiries” on your credit report. If you have applied for too many new accounts recently, it could negatively effect your credit score. Every inquiry isn’t counted: for example, inquiries by creditors who are monitoring your account or looking at credit reports to make “prescreened” credit offers are not considered liabilities.
- How many credit accounts do you have and what kinds of accounts are they? Although it is generally considered a plus to have established credit accounts, too many credit card accounts may have a negative effect on your score. Also, many scoring systems consider the type of credit accounts you have. For example, under some scoring models, loans from payday loan companies may have a negative effect on your credit score.
Oct 16, 2018
Scoring models may be based on more than the information in your credit report. When you are applying for a mortgage loan, for example, the system may consider the amount of your down payment, your total debt, and your income, among other things.
Before you start house hunting, get pre-qualified or pre-approved for a mortgage. The lender will review your credit score and be able to give you personalized advice on your mortgage options based on your credit report and credit score.