What Is a Credit Score and How Can it Help You Buy a Home?

Last updated on December 17th, 2024

Credit scores are used by mortgage specialists to help evaluate the credit of an applicant. The most well-known credit score, the FICO score, is used in over 90 percent of lending decisions. Lenders may check your credit score when you’re buying a new car, or for your mortgage on a vacation home. Your credit score may also be used as a basis for every day credit-related decisions such as credit card approvals, condo rentals, and employment background checks.

 

What Is a Credit Score?

A credit score is a number that gives lenders a quick and easy understanding of how a borrower handles their debt. Higher credit scores often indicate a more responsible use of debt. Two individuals may earn the same salary and both may buy a new SUV, but how they choose to pay off their auto loan can affect their credit. If one pays their bill each month on time, while the other misses a few payments while they’re on vacation or traveling for work, those late marks on their credit may affect their credit score. Also, if one maxes out their credit cards for the down payment, while the other pays for part of the vehicle in cash, the individual utilizing a greater percentage of their available credit may also notice a decrease in their credit score.

The FICO score is the most common credit score, but other scores like the VantageScore are also used by lenders. Each month, financial companies like credit card issuers or auto and student lenders report data to the three independent credit agencies: Transunion, Experian, and Equifax. These agencies use the reported data to compile individual credit reports, which become the basis for credit score calculations.

Factors that Go into a Credit Score

Credit scores are based on a mathematical formula that incorporates a variety of factors. Most FICO scores range from 300 to 850. Here are the five main factors that FICO uses to calculate their score:

1. Payment History:

Your history of paying on time is the most heavily weighted factor for FICO scores. An occasional late payment may not have a significant effect on your overall credit picture, but credit scores go down with habitual late payments.

2. Amounts Owed:

Larger debt may lower your credit score, especially if you’re near the limit of every revolving credit account, like credit cards.

3. How Long You’ve Had Credit:

Establishing a credit history takes time and you may not see an immediate lift in your credit score when opening a credit account. If you’ve only recently opened a credit card, the scoring models may need months, or years, of consistent account usage to properly assess your ability to handle debt.

4. New Credit:

An unusual spike in borrowing activity could affect your credit score. When lenders evaluate a loan application, they may request what’s known as a “hard pull” and receive data from your credit report. These hard pulls can affect your credit score somewhat, but generally, inquiries only have about a 10 percent effect on your credit score, according to US News & World Report. Alternatively, prospective employers or loan issuers checking credit for pre-approved offers may do a “soft pull,” which doesn’t affect a credit score.

5. Credit Mix:

Generally, it’s a good sign if you’re carrying an appropriate amount of credit in different forms. If you show that you’re paying off a credit card, a student loan, a car loan, and possibly a mortgage on time each month, this will demonstrate that you’re able to handle credit and your credit score should reflect this activity.

 

Credit Scores for Married Couples

According to Experian, although jointly-held accounts appear on both partners’ credit reports, credit history is tracked and reported separately. A credit score is an individual calculation and each person in the marriage will have a different score.

 

Evaluating Your Credit

You can request one free credit report each year, which is considered a “soft pull” and will not affect your credit score. When reviewing the report, it’s important to look for obvious mistakes and make sure they’re reported back to the credit bureau. You should also check to make sure old accounts that have been paid off or closed are properly reported.

 

How to Improve Your Score

Lowering your debt and avoiding late payments are two of the best ways to improve your credit score. When evaluating your credit, you may also be given reason codes, which are the main factors currently affecting your score. The reason codes may say that your accounts are too new to be rated if you’ve recently opened a new credit card to take advantage of travel rewards. Or, if you have recently completed a large remodeling project using your home equity line of credit, you may see a notice that you currently have too much outstanding debt, compared to your credit limits. You may also choose to use available credit for strategic tax planning or investment opportunities. If you’d like to improve your score, but aren’t sure where to start, use the reason codes to take action and decrease your debt-to-credit ratio.

If you’re still wondering what is a credit score, keep in mind that it’s one of several factors affecting your mortgage approval. Credit scores are widely used because they’re a simple way to boil down an individual’s often complex credit history. Mortgage lenders use certain thresholds for credit scores, which can affect the type of mortgage they’re able to offer certain applicants. By understanding what your score means and where it falls in the range of acceptable scores, you can improve your finances and better your chances of buying your dream home sooner rather than later. Whenever you’re ready to build your brand new home, Toll Brothers and Toll Brothers Mortgage can help make your dream a reality.