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Credit Score – Five Components Used in Calculating Your Score

Did you know that a person’s credit score is highly crucial to the home-buying process? Short answer: It is.

As a first-time homebuyer, your FICO score (or Fair Isaac Corporation score) determines whether you qualify for a loan and also the mortgage terms. Normally, credit scores range from 300 to 850, and if you are within a certain range, you can qualify for a mortgage loan or not.

Why is Credit Score Important When Buying a House?

Although you don’t need to aim for an exact score of 850, there are specific score requirements you have to meet to get a mortgage. As a home buyer, you should aim to keep your score over 760. As noted by CNBC, a high score makes a significant difference in the money you pay in the course of the loan.

 In other words, your credit score has the following effects:

  • Determines the loan options to consider: Different loan types have varied minimum scores.
  • Impacts the overall cost of your loan: The higher the score, the lower the interest rates.
  • Determines if you qualify for a loan: The lower the score, the higher the risk of loan defaulting and lessen the likelihood of mortgage approval.

In this context, you will potentially save thousands of dollars in interest payments if your credit score is high.

How is Your Credit Score Calculated?

Everyone has a credit report. The FICO score has been a fixture in consumer lending in the United States since the 1950s and is determined by how much consumer credit risk you pose as a potential homebuyer.

This score is an individual’s credit report that determines their creditworthiness. Once your rate is determined, the company provides a borrower’s FICO scores to lenders.

Here are five components used when calculating your credit score:

1. Payment History

This component takes up 35% of your credit score. Most of us have borrowed money in the past. If you have credit accounts, this component assesses whether you have been paying them consistently as well as on time.

It also factors in various factors such as:

  • Bankruptcies
  • Delinquencies
  • Collections

This element takes a close look at the size of these problems as well as the time it took you to resolve them. It also explores how it has been since you had these problems. If you have a lot of payment issues in your credit history, your credit score will be adversely affected.

2. Amount Owed

This element takes 30% of your credit score. It measures the amount you owe against your available credit. In other words, do you spend above your credit limit? If this is the case, lenders see you as a potential risk to loan default.

According to Better Money Habits, the credit score formula looks at the different accounts that you have as well as your current amount of debt. If you have huge debts from different sources, your credit score will most likely be low. In most instances, lenders prefer borrowers whose credit utilization ratio is below 30%.

3. Length of Credit History

This component accounts for 15% of your credit score. It asks a simple question: How long have you been using your credit accounts? Let us put it in simpler terms. How long have your credit accounts been open? How long have they been in good standing?

Think about two borrowers. One has never been late with loan repayment for 20 years. The other one has been on time for three years. Who among the two has a high credit score? For obvious reasons, the one whose credit account has had a good standing for 20 years is more creditworthy.

4. New Credit

This element takes 10% when calculating your creditworthiness. Before we look at its effects on your credit score, just reflect on how frequently you apply for credit. For your information, people who occasionally apply for loans are believed to be in financial distress.

Who wants to give a mortgage to such a person? So, every time you apply for a loan, just know that your credit score gets dinged. Every time you are opening a credit account, think about its effects on your credit score.

5. Credit Mix

This element also accounts for 10% when calculating your credit score. Let us ask you a simple question. What type of credit accounts do you hold? These accounts can either indicate a healthy or unhealthy credit mix for you.

What constitutes a healthy credit mix? It is your ability to successfully manage a wide variety of credit. Think about installment credit as well as revolving credit. If you have them and have efficiently been using them, then your credit score will be high.

The Final Thought

If you are planning to buy a home, your credit score will play a fundamental role in the process. It affects not only your loan options but also the cost of your loan. It’s important to understand how the credit score is calculated to avoid habits that may adversely affect it.

If you’re ready to start the process of purchasing a home, the Path and Post team can help. Contact us for real-time updates, so you can find and tour homes fast.

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