One factor in the homebuying process determines how much you pay for your mortgage, how much home you can buy, and in some cases, whether you can buy a home or not. It may be the most important number you’ll deal with through the entire process. What can possibly have that much power when you’re buying a home? It’s your FICO score.
With a low FICO score, your interest rate can be astronomical, definitely not the four percent you hear about in the news. Too low, and you don’t qualify for a mortgage at all. An “okay” FICO score won’t stop you from getting a mortgage but a great score gets you the best interest rate and most financing.
Anyone with debt knows that FICO scores exist, but few people understand how a score gets calculated and how much control you actually have over it. Before you’re truly ready to buy a home, your finances need to be in order. One key part of that is your FICO score.
What is a FICO Score?
Your FICO score is a number, between 300 and 850, assigned to you once you take on debt - credit cards, auto loans, student loans, mortgages, etc. The number lets your lender know what kind of financial risk you represent. If your score is high, lenders believe you’re more likely to pay your bills on time and pay the balance of your loans. Low scores indicate you don’t always pay your debts and may default.
Lenders will check your credit when you begin the mortgage application process. Your FICO score, as well as other things like income level, lets them know if you qualify for any of their mortgage products. If not, most lenders will let you know what to do to increase your chances of approval. One of those steps is often to improve your FICO score.
To increase your score, there are several things you can do. Pay off or down existing debt. Always pay your bills on time. Don’t open any new lines of credit as your score is affected each time a request for more credit is made.
FICO Score Calculations
To calculate your FICO score, five distinct factors are used. While all five factors are important, some carry more weight than others.
Payment History: The most important, it makes up 35 percent of your total score. Late payments and defaulted loans bring down your score. Pay your bills on time and consistently, and over time, your score will improve.
Amount Owed: The next in the list, the total amount of your debt accounts for 30 percent of your score. Carrying debt isn’t a problem, but multiple loans with high balances can be. Too much debt puts you at risk of default if your income decreases.
Credit History: Your history accounts for 15 percent of the total. A longer history, especially a positive one, makes you a better credit risk. It shows you’ve been creditworthy for a while and that you pay your debts.
Type of Debt: What kind of debt you have accounts for 10 percent of the total score. All debts are included in this calculation, but some debt is better. The type of debt matters less than whether you pay them on time, though.
New Lines of Credit: Ten percent of your score looks at how many times you’ve opened (or attempted to open) new lines of credit. A flurry of activity makes it seem like you don’t have the cash you need and can make you look like a potential credit risk. One or two new accounts is no big deal, but multiple accounts in a short amount of time can lower your FICO score.
Exactly how a credit score is calculated is complicated, proprietary, and not readily available information. The bottom line, though, is that keeping your debt low, paying your bills on time, and having a positive credit history helps your FICO score. Before you try to buy a home, talk to a lender to discuss your credit history and FICO score. You can’t control how your score gets calculated but you can affect whether it’s positive or not.