Raymond C. McMillan, BA., Mortgage and Real Estate Advisor – May 17, 2020
In our previous blog we briefly touched on the importance of your credit profile and debt, and how it affects you in the mortgage application process. Your credit profile or credit report gives the lender a snapshot at the way you manage your finances, so they can determine if you are a good or bad credit risk when it comes to lending you money. So how is your credit profile or credit score determined? There are five categories that impact the calculation of your credit score. They are:
- Types of Credit
- New Credit
- Length of Credit History
- Amounts Owed
- Payment History.
Each category has a weight that is used in your credit score calculation and impacts your credit rating.
TYPES OF CREDIT used by you will have an impact on your credit rating. What do we mean by type of credit? Here we are referring to the types of lenders that currently hold any loan you have outstanding. Someone who has finance company credit products and department store credit cards will usually have a lower credit score than someone who uses the financial products of major banks, credit unions and trust companies. Similarly, financing your automobile through the manufacturers finance division or your financial institution will also more positively impact your credit score than using a secondary automotive finance company.
NEW CREDIT also has an impact on your credit score calculation. A high amount of new credit accounts will usually have a lender asking questions. You may wonder why? Usually it is because it is usually an indication of two things, the person has had credit issues in the past and are currently rebuilding their credit rating or they are a credit seeker trying to get access to as much credit as they can in a short space of time. The former is not a major issue for most lenders, providing there is a reasonable explanation, but the latter could be a red flag for some lenders.
LENGTH OF CREDIT HISTORY has a relatively significant impact on your credit score. The longer you have had credit products, the more comfortable the lender will be with you as it displays financial maturity and responsibility. So, it is important to keep that first credit card you ever got with a five hundred dollar credit limit when you sixteen or seventeen years old. While most lenders will want to see a credit profile that is one to two years old, a recent credit profile with a 800 credit score may not be as impressive as a 680 credit score that has reported for more than ten years. Mortagge lenders want to see more than just a high credit score, they want to see how you have managed your debt and credit repayment over an extended period.
AMOUNTS OWED on your credit cards has the second highest impact on calculating your credit score. When applying for a mortgage, lenders are more reluctant to loan money to potential homebuyers who have high amounts of consumer debt – either revolving or instalment. If the amounts owing on your credit cards are at or near the limit for most of the credit reporting cycles, this will significantly lower your credit score. However, of all the variables that impact your credit score, this is perhaps the easiest to remedy. If you have an established credit profile with no payment delinquencies but have credit cards that are all at the limits, paying them off or down to less than half of the credit limit can see your credit score increase by several points in a month to two months.
PAYMENT HISTORY is our final and perhaps most important variable in computing your credit score. The approach here is quite simple – pay your bills on time to maintain a decent credit rating. I always say, “bad things sometimes happen to good people” and these bad things could be anything from job loss to illness to divorce, could significantly affect your ability to pay your bills on time. If you find yourself in any of these situations my advice is to contact your credit grantor and let them know your circumstances so they can work with you and protect your credit rating. It is important to make your payments on time both on your credit cards and instalment loans and avoid late payments and delinquencies. Most mortgage lenders will look at your payment history over the last year or two when reviewing your application to make a lending decision.
Keep in mind a poor credit score is not a life sentence and can be fixed with a few steps. In the case of delinquent debt that has been transferred to a collection company, settling that debt and repairing your credit is a quite simple process.
As a consumer, it is important to check your credit profile periodically to ensure there are no inaccuracies. To check your credit score, you can contact one of the three major credit reporting agencies: Equifax Phone: 800-685-1111, Experian Phone: 888- 397-3742 and TransUnion Phone: 800-909-8872.
The writer: Raymond McMillan is a mortgage broker and real estate consultant and principal of The McMillan Group who has been in the banking, mortgage and real estate industry since 1994. He has been licensed as a mortgage broker since 1999 and has helped many people purchase their homes and invest in real estate. You can reach him at 1-866-883-0885 or visit www.TheMcMillanGroupInc.com