How Your Credit Score Affects Your Investment Purchase

If you’re thinking of using a mortgage loan to buy a home, eventually your “credit score” is going to become an issue.

It may feel like you’re back in high school, being sorted by the “A students” and the “C students.” You may even feel like you’re being called into the principal’s office to explain yourself for that car payment you missed back in 2017 when you were between jobs.

It’s not fun … and it’s made even less fun by the fact that these numbers are shadowy and often misunderstood. Let’s shine a light on credit scores — what they are, how they affect your home purchase, and what you can do to raise your score.

What Is a Credit Score?

A credit score is a numeric score that various third-party reporting agencies use to assess your risk as a borrower — that is, how likely you are to pay on-time and in-full according to the terms of a loan or payment plan.

These credit companies scrape data reported by creditors to one or more of the three major credit reporting bureaus in the US — Equifax, Experian, and TransUnion — and boil all that data down to a single numerical score between 300 and 850.

Here’s how the scores break down:

• 300-579 = Poor
• 580-669 = Fair
• 670-739 = Good
• 740-799 = Very Good
• 800-850 = Excellent

The most respected is the FICO (Fair Isaac & Co) score, but other companies produce credit scores as well.

How Your Credit Score Affects Your Purchasing Power

Your credit score affects your home purchasing power in several ways. First things first — below a certain credit score, you may not qualify for a mortgage loan at all. The bottom is usually 620, though FHA loans go lower.

Above this bare minimum, your credit score may affect how big of a loan the lender may be willing to extend to you. You may have a high income and great debt-to-income ratio, but if you have a history of late payments reflected in your credit score, the lender may not be willing to lend the maximum they would otherwise lend to someone with your income or DTI.

Additionally, a lender may not be willing to max out their loan-to-value ratio for a borrower with a lower credit score. This might mean you have to make a higher down payment.

For example, a lender might lend as much as 95% LTV for borrowers with good credit, requiring them to put only 5% down. But for a borrower with poor credit, that might seem too risky for them. They might only be willing to extend 90% LTV, forcing the borrower to come up with 10% down instead of 5% down.

How Your Credit Score Affects Your Interest Rate

Another major factor in mortgage affordability is the interest rate. The interest rate on a loan is the fee you pay to your lender for the privilege of borrowing their money, usually expressed as an annual percentage rate (APR).

How much interest the lender demands usually depends on the perceived risk to the lender. Mortgage loans usually have the lowest interest rates in the business because the loans are secured by real estate, which is easy to appraise and relatively easy to repossess in the event of default.

But if the borrower has poor credit, however, that makes the loan look riskier to the lender. After all, the borrower could miss payments or default on the loan, leading to costly collection and foreclosure efforts on the part of the lender. To mitigate this risk, lenders will charge higher interest rates to a lender with lower credit.

The lowest interest rates are usually available to borrowers with credit scores of 740 or higher, maybe 750 or higher. Borrowers closer to the minimum threshold of 620 will usually face the highest interest rates offered by a lender.

A higher interest rate means higher monthly payments and more interest paid to the lender over the life of the loan. That higher interest rate can make a big difference in affording the home you want.

How to Raise Your Credit Score

Is your credit score lower than you would like it to be? Here’s how to raise your credit score and put yourself in a more favorable position for your home loan …

Check Your Credit Reports

Once a year you are allowed to pull your credit reports from the three major credit bureaus — Equifax, Experian, and TransUnion. This is easy to do online. If you have already gotten your free report for the year, you can order another one for a small fee.

Each report should have the “negative” entries grouped together in its own section. Look at anything negative on your credit report. Are any of them inaccurate? This is more common than you think.

If you see any negative entries that shouldn’t be on there, you have the right to dispute them with the bureaus. If the creditor can’t validate the entire, the bureaus will take it off your report, and your credit score will go up!

Pay Your Bills On Time

The most important component of your credit score is that you pay your bills on time. Rent or mortgage, car note, phone bill, insurance premium, utility bill, credit cards, everything. Even making the minimum payment on your credit cards satisfies this requirement.

If you have been significantly late on even one bill, it can negatively impact your credit score for up to seven years. But the more time you put between today and the missed or late payments, the better your score will be.

After seven years, the credit bureaus are required by law to take those late or missed payments off your credit report. If you see any late payments on your report that are over seven years old, you have the right to demand that they be removed.

Avoid Court Judgments Against You

Evictions, foreclosures, bankruptcies, and other court proceedings against you create a negative entry on your credit report that can last up to ten years. If you are facing proceedings like this, seek professional help immediately to avoid this fate.

Settle Past-Due Accounts and Collections

If you have the money to pay past-due accounts or collections in full, call the collections department. Collections agencies will often settle the account for less than the outstanding amount due or put you on a payment plan … but to incentivize payment in full, many will offer to remove the negative report to the credit bureaus if you pay in full.

Only try this if you are able to pay in full, and make sure that they intend to completely expunge the credit record. If they simply list it as “Paid Off” or “Charged Off,” it still negatively affects your credit.

Lower Your Revolving Debt Balances

Revolving lines of credit include credit cards, HELOCs, and other lines of credit where you can spend at will against a credit limit and then pay back the balance over time. A big portion of your credit score looks at how much of your revolving credit you have used up — in other words, how close you are to being “maxed out” on your credit cards or other lines of credit.

If you have 30% or more of your revolving credit limits used up, see if you can pay it down below 30% in total and preferably no more than 30% on any given account. For example, if you have five credit cards with $10,000 balances for a total of $50,000 in credit limits, try to get the total balance down below $15,000 with no card at more than $3,000.

Whereas it takes up to seven years for missed bill payments to leave your credit report, reducing your revolving debt balances can actually cause your credit score to spike up quite quickly — almost overnight.

Increase Your Credit Limits

If you don’t want to pay down your revolving credit balances that much, another way to get them below 30% is to request a credit limit increase. This might get you down below that magic 30% number — not because you paid them down, but because you pushed your credit limits up!

Of course, if you then proceed to max out that new higher credit limit, it was all for nothing — your credit score won’t improve and you’re deeper in debt, so proceed with caution.

Increasing your credit limit may also require the creditor to pull your credit report, which temporarily lowers your credit score (for about a year) so this may be a risky move if you plan to apply for your home loan in less than a year.

Get New Lines of Credit

There is a portion of your credit score for how many lines of credit you have — and believe it or not, more is better. By getting more credit accounts, you can actually increase your credit score. The optimal number of accounts is 20 or more.

The rationale here is that if you have a lot of accounts, you must be a good steward of your own credit — provided that you don’t miss payments or max out the accounts!

One of the easiest ways to up your number of accounts is to apply for more credit cards. Beware! If you miss payments, carry high-interest balances, or max out these new credit cards, they could do a lot more harm than good to your credit score, so proceed with caution.

Applying for new credit accounts also requires the creditor to pull your credit report, which temporarily lowers your credit score (again, for about a year) so think hard about trying this if you’re less than a year out from your home loan application.