Homebuying 101

Debt & Credit Score

Your debt and credit score will matter when you get a mortgage. Demystify your finances and how they impact your mortgage.

Questions & Answers

What is FICO?

FICO is the most common credit bureau risk score—generally referred to as a credit score—used by lenders to determine your credit risk. In general, it is designed to predict how likely you are to pay back a loan in a timely fashion, based on your credit report. Most lenders use your FICO score when determining your interest rate and the type of mortgage loan you qualify for.

What does FICO stand for?

FICO stands for Fair Isaac Corporation, a company that developed a model to determine credit scores. Each of the three credit bureaus (Equifax, Experian, and TransUnion) calculates a FICO score based on information they have about your credit history.

How is FICO/credit score calculated?

To calculate your score, each of the credit bureaus look at all of your credit information, which is split up into five categories:

• 35%: payment history: whether you’ve paid your past credit on time

• 30%: amount of debt you owe: overall debt

• 15%: credit history: how long you’ve had your credit accounts, and how long it’s been since you used certain accounts

• 10%: new credit: new accounts you open; opening several credit accounts in a short period of time can have a bigger impact on your credit

• 10%: credit type: your mix of credit accounts, including credit cards and loans from mortgage and finance companies

The percentages show the importance of each category when calculating your credit score, but the influence of one catgory can change depending on your situation and the length of your credit history. And, since your credit history on file at the three credit bureaus may vary slightly based on what creditors have reported about you, your three scores could be different.

What exactly is in my credit score?

Your credit score is made of:

• 35%: payment history: whether you’ve paid your past credit on time

• 30%: amount of debt you owe: overall debt

• 15%: credit history: how long you’ve had your credit accounts, and how long it’s been since you used certain accounts

• 10%: new credit: new accounts you open; opening several credit accounts in a short period of time can have a bigger impact on your credit

• 10%: credit type: your mix of credit accounts, including credit cards and loans from mortgage and finance companies

How do I check my credit score?

You can check your credit score for a nominal fee by visiting www.myFICO.com. While it doesn’t include your credit score, you can also request a free credit report once a year from each of the three credit bureaus via www.annualcreditreport.com.

Does checking my credit score affect my credit?

Checking your own credit score won’t affect your credit, but a creditor (e.g. a lender) doing a credit check—called “pulling your credit”—can. There are two types of credit inquiries:

soft pulls and hard pulls. If a creditor is going to check your credit, you can ask if it’ll be a soft or hard pull to better prepare for how it might impact your credit. Soft pulls have no impact, while hard pulls will.

What is a credit "soft pull"?

A soft pull is a credit check that doesn’t require your consent and isn’t a formal application for credit. Soft pulls use information about you that’s public, like your street address, but not private information like your Social Security Number. Therefore, soft pulls provide an estimate of what your rate could be. When shopping around for a mortgage, potential lenders will use a soft pull to quote your rate, which is why the rate can sometimes change by the time you’re ready to get pre-approved.

Soft pulls also don’t show up on your credit score, which will help preserve your credit since too many checks can be a red flag for lenders.

What is a credit "hard pull"?

A hard pull is a credit check that’s done when you apply for credit, and a creditor will need your authorization to do one. Hard pulls also show up on your credit report, which means that creditors who do soft and hard pulls in the future will see them.

What types of things count as a "soft pull" on my credit?

Soft pulls are used when an employer conducts a background check, or when you check your own credit. Banks will also do a soft pull before they send you credit card offers in the mail. Again, soft pulls do not show up on your credit reports and do not affect your credit score.

What types of things count as a "hard pull" on my credit?

Hard pulls are used when you apply for credit. This includes any time you open up a credit card, mortgage loan, or auto loan. Hard pulls do show up on your credit report, and having too many of them could be a red flag for some lenders. However, it's understood that you'll shop around for rates, so multiple hard pulls from different lenders in a short amount of time only count as one hard pull on your score.

Does a "soft pull" on my credit affect my credit score?

Soft pulls have no impact on your credit score.

Soft pulls have no impact on your credit score.

A hard pull will show up on your credit report for two years, and can, subsequently, slightly lower your credit score. Plus, the more hard pulls you have on your credit report, the riskier you’ll appear to lenders, so it’s wise to think twice before authorizing too many hard pulls on your credit. The weight lenders give to the number of inquiries on your credit differs depending on your income and credit history, but most experts recommend keeping hard pull authorizations to a maximum of 10 per year. However, it's understood that you'll shop around for rates, so multiple hard pulls from different lenders in a short amount of time only count as one hard pull on your score.

What is credit utilization?

Credit utilization is the amount of total credit you actually use. You can calculate your utilization ratio by dividing your balance by the credit limit for your account. The higher your utilization ratio, the more likely you are to experience financial difficulty; thus, the riskier you appear to lenders. Keep in mind that closing a credit card removes a line of credit, which can increase your utilization ratio. So, sometimes it makes sense to keep a few credit cards open, even if you don't use them, and especially if they have no annual fee!

I keep getting pre-approved for credit cards, is there harm in opening them up?

Opening up a credit card means a creditor will do a hard pull on your credit, which can negatively affect your credit score. In addition, having multiple credit cards puts you at higher risk of falling into debt, so it’s suggested you keep your number of credit cards to a minimum. According to Gallup, the average American has 3.7 credit cards, but the most important thing to keep in mind is to only open as many cards as you can manage.

Will it help if I just close all my credit cards and simplify to one?

It’s never recommended to close credit cards, especially as you’re preparing to finance a major purchase. Lenders pay close attention to factors associated with credit cards, with two of the most weighty being:

• Credit card utilization rate: Or, the amount of your overall credit you’re using. When you close a card, you reduce your available credit, making it tougher for lenders to tell how you handle credit.

• Average age of accounts: Lenders consider the first time you opened a credit card as the start of your credit history. Closing a card that was opened early on will reduce the length of your credit history.

How do I know if I should close a credit card?

If credit cards cost you money unnecessarily, you should look into closing them. Cards with an annual fee or high interest rate are the biggest culprits. However, you should try to avoid closing your very first credit card since bureaus use the length of your credit history to determine your score. Before you start the process of closing any card, reach out to the lender to see if they’ll agree to adjust your terms.

Is your credit affected by how many lines of credit you have (i.e. credit card, personal loans, etc.)

Each line of credit contributes to your credit mix, so it can be helpful to have various types of credit to prove that you can manage each responsibly. However, the more credit cards you have, the more tempted you may be to use them—thus increasing your balances and, subsequently, your utilization rate—which can have an impact on your credit. Therefore, it’s wise to only open as many lines of credit as you can manage. While there's no "right" number of cards to have, according to Gallup, the average American has 3.7 credit cards.

What are the credit score ranges?

Credit scores range from 300-850, though the particular ranges for what’s considered “excellent,” “good,” “poor,” and “bad” are subjective. Overall, the higher your credit score, the lower your credit risk in the eyes of lenders. FICO scores certainly help in a lender’s decisionmaking process, but a lender will look other factors in addition to your credit score when considering you for a mortgage loan.

What is a perfect credit score?

A perfect credit score is considered to be 850.

What types of activitites register as a "hard pull" on my credit report?

Hard pulls occur when you apply for credit, such as a mortgage loan, auto loan, or credit card.

How many "hard pulls" on my credit report am I allowed to have per year?

While there’s no limit to the number of hard pulls on your credit each year, it’s recommended that you keep them to a minimum, since they have a negative impact on your credit score. The weight lenders give to the number of inquiries on your credit differs depending on your income and credit history, but most experts recommend keeping hard pull authorizations to a maximum of 10 per year. Plus, the more hard pulls you have on your credit report, the less likely you are to be approved for credit, such as a mortgage loan.

What credit score do I need in order to finance the purchase of a home?

When financing the purchase of a home, the required credit score depends on the type of mortgage loan. Generally, the higher your credit score, the better your mortgage rate; however, certain loan programs accept lower credit scores.

How long will it take me to build up the credit necessary to buy a home?

While it depends on your credit mix and the type of loan program you choose, it will typically take you a few years from when you initiate your first line of credit to build up the credit necessary to buy a home. Lenders will consider your initiation of credit as the day you opened your first credit card, so it’s important to keep that card open even if you no longer use it.

How does your credit score affect your loan rates/terms?

Your credit score can have a big impact on your loan rates and terms; lenders will consider your credit score before extending you a mortgage loan. You’ll generally receive competitive mortgage rates when your credit score ranges from 720 to 760 (and up), but there are loan programs available for those with lower credit scores.

What is considered a bad credit score rating?

Although good and bad credit scores are subjective, anything above 700 is generally considered a good credit score, whereas anything below 650 may require some work to get the best rates. However, there are ways to repair your credit, and certain loan programs are available for borrowers with lower credit scores.

What are the most common causes of a low or bad credit score rating?

Low or bad credit scores typically come from late payments on a credit card or loan, high balances, public records like bankruptcy, and/or too many hard pulls on your credit.

How do I repair my credit?

Keeping in mind that it takes time to repair your credit, there are a few steps you can take. First, check your credit report to make sure it doesn’t have any errors. If anything is incorrect, you can dispute it with the respective credit bureau. Second, set up payment reminders so that you make all your monthly credit payments on time. Third, don’t open up too many credit cards in a short period of time, especially if you have a short credit history—this can appear risky to lenders. Fourth, reduce the amount of debt you have. While this is easier said than done, you can work to reduce it by using fewer credit cards and by keeping balances low. However, don’t stop using credit cards completely. Showing that you can responsibly manage them each month—rather than not using them at all—will improve your credit.

How long does it typically take to repair your credit?

The time it will take to repair your credit will depend on the reason you need to do so. The more negative credit changes you have, the longer it’ll take you to repair it. Remember, there aren’t any quick fixes that will effectively repair your credit, but working to gradually repair it can help you improve and maintain your credit in the future.

Are there programs for people with low credit scores?

FHA loans are available for borrowers with low credit scores who don’t qualify for conventional loans. FHA loans are extended to borrowers with credit scores as low as 500, though the lower your credit score, the higher your down payment will need to be. In addition, the FHA recommends a Credit Counseling Program for borrowers with low credit scores, which will increase the chances of being approved for an FHA loan.

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