What's a Good Credit Score and Why Does it Matter?

Your credit score is so important throughout your life that it should be taught as part of a standard curriculum for financial literacy and adulthood. Unfortunately it isn't and in this instance, ignorance is anything but bliss. In this blog, we're going to take a deep dive to explain the importance of your credit score, how it's determined and steps you can take to improve it. My NC Homes would like to help our would be home buyers understand how your credit impacts not just your ability to purchase a home but also the terms you'll be given. Just because your credit is fair on one report, it still might not qualify for the lowest available mortgage rates. You may also be rejected depending on the types of debts you have incurred. Alternatively, you might qualify for a loan with poor credit depending on who is issuing the loan, but you definitely won't be getting the best possible terms and interest rates. Let's dive into what we think should be part of everyone's life curriculum, Good Credit 101.

Your Credit, According to 3 Bureaus

Experian, TransUnion, and Equifax are the three largest credit bureaus that determine your overall credit score. They do not all use the exact same formulas nor do they all receive the exact same information. When applying for a mortgage, the scores from each of these companies is factored in; this is frequently referred to as a "Tri-Merged" credit report. For this reason home buyers need to be aware of all three scores.

Top 5 Factors contributing to your Credit Score

There are five key factors that contribute to your credit score. Keep in mind that these are weighed differently depending on the lender and the credit bureau.

1. Payment History: The payment history is whether you pay on time or your accounts are frequently late. This is 35% of your credit score.

2. Ratio of Debt to Credit: It is best to keep your credit at about 30% use. So if you have a credit limit of $1000, the card balance should remain at $300 or lower. The ratio accounts for around 30% of the credit report.

3. Credit History/Age of Debt: The older your accounts, the better. This is one of the credit misconceptions. If you have an account, paying it off and closing it, is not actually beneficial to your credit score. Keep the account lower than 30% ratio. This accounts for 15% of your credit score.

4. Account Mix: The account mix refers to credit cards vs loans. Depending on your mix, your score may be higher or lower. Loans are secured by property, your home or car for example, why credit is unsecured.

5. Credit Inquiries: Each time you apply for a loan or credit card, or simply request it, your credit report is assessed and requesting too often negatively impacts your credit score. Please note that your credit score and your credit report are different. Your credit report is what your lender will use while your credit score (What you see on sites like Credit Karma or Credit Sesame) is an approximation and most often only represents the information from one of the three credit bureaus

Poor, Fair, and Good Credit Scores and What They Mean to Mortgage Lenders

The five factors are assessed by credit bureaus and you are assigned a score. The FICO Score, is a particular score with a set of criteria used by lenders, is the score that you will base your mortgage qualification off it. Here is the breakdown of the FICO scores and what they mean for lenders.

FICO scores range from 300-850. Using the 5 factors above, the FICO score is broken down by 35% Payment History, 30% Ratio of Debt to Credit, 15% credit history, 10% type credit in use, and 10% New Credit. You may qualify for government loans with poor credit and further down we have a guide of what type of loan you may qualify based on your FICO score.

Poor Scores: 300-580

Fair: 580-669

Good: 670-739

Very Good: 740-799

Excellent: 800+

What is a FICO Score?

In 1958, Bill Fair and Earl Isaac, a mathematician and engineer, formed a company in San Rafael, California. They created tools to help risk managers make a better decision when taking financial risk. Today, 90 percent of all lenders use theFICOscore, first created in 1989 by Fair Isaac, and it's theonlyscore Fannie Mae and Freddie Mac, the Federal Housing Agency and Veterans Affairs will accept in underwriting loans they guarantee.

What is a Consumer Score?

The three credit bureaus, in their understanding of the credit scoring model created by FICO, decided to create their own scoring models, and in 2004 -2006 they unveiled the consumer scores:Plus Score,Trans Risk Score,Equifax Credit Score, andVantage Score. However, these are not genuine FICO scores, and mortgage lenders don't use them and the reason is pretty easy to understand,Would you buy a watch that gives the approximate time of day?

The three credit bureaus all work with major financial institutions, professional organizations, comparison sites, personal finance businesses, clubs such as Costco, AAA, Sams Club, and many data-mining brokers all racing to take advantage of consumer fears. All offer some version of afree credit score;most with the enticement of a consumer score that is not used by lenders. These offers are made in hopes of obtaining subscriptions or fees from consumers. Trust us, there's absolutely no reason to pay a fee for your credit score.

Know Your Score

Gaining access to one's own credit report and credit score prior to loan approval with no strings attached is absolutely to your advantage. With a little effort, inaccuracy of information can be instantly corrected at the credit bureau level, and with a few simple steps, credit scores could be enhanced. For example, paying down revolving account balances before a creditor's statement-ending date (the creditor later updates account information with the credit bureaus), thus reducing revolving account balances at a particular point in time, will positively add more points to a score. Your credit score will impact every single loan you ever apply for, the rates your charged on credit cards, cell phones, rent etc. This is why we strongly advise our clients on the value of knowing and maintaining a good credit score.

Consumers have a legal right to access their annual credit report at no charge once a year from annualcreditreport.com, a site sponsored by the three major credit bureaus: Experian, Equifax and TransUnion. This is the only site for your free credit reports as authorized by Federal law.

These reports provide all the basic consumer data, but do not reveal a credit score. If you have a need for the FICO credit score that is actually used by mortgage lenders,myfico.com is the website to visit. For $19.95 per bureau, consumers can purchase a customized credit report with a genuine FICO score.

Mortgage Loan Types

1. Conventional Loan

Today a conventional loan requires a minimum credit score starting of 620, however according to Ellie Mae, the average score for buyers using conventional loans in 2020 was 756. It depends on the other terms of the lending. If you put down a larger down payment, your credit score may not need to be as high. But, you may not qualify for the lowest mortgage rates.

2. FHA Loan

A FHA Loan is a Federal Housing Loan and if you have a score of 500, you could qualify with a 10% down payment. According to Ellie Mae the average score for homebuyers using an FHA loan was 680 in 2020. These loans require Private Mortgage Insurance {PMI}

3. VA Loan
   

If you qualify for a Veterans Affairs loan, you are not necessarily held to the same FICO standards, VA Loans only require a minimum score of 580 but the average 6 months score in 2020 for VA loans was 711-721. These loans are available with no money down and no PMI requirements

4. USDA Loan

The USDA, US Department of Agriculture loans are offered in rural areas, they can be for up to 100% and do not require PMI. Most require a minimum score of 640 some lenders will accept scores as low as 580

Currently without relying on a co-signer, in order to obtain lending that is most favorable right now, your FICO credit score should be at 740 or higher. Mortgage rates are still low, but lenders are not offering the lowest rates to the lower scores. If you have the minimum score and little to no down payment, it will be difficult to secure lending with many of the favorable rates and terms that you see offered online and in print advertisements.

If you are looking to buy in Chapel Hill, Durham, Apex, Cary, or the Research Triangle Area, we are your area experts. We offer over 50+ years of combined experience to buyers and sellers in the Triangle and if you need help securing lending, we have a list of trusted lenders who understand the right loans for our buyers. Contact us today!

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