Homeownership and Credit
Your credit score is a number generated by factors present in your credit report, a record collected by a credit reporting agency. Most credit reports and scores are supplied by one of the three major national credit reporting agencies: Experian, TransUnion, and Equifax.
Each agency uses a slightly different method calculate a credit score, but they all rely on software developed by Fair, Isaac, and Company (FICO). These credit scores are referred to as FICO scores which range from 300 to 850. The information on your credit report that determines your credit score includes:
- Payment history (whether you’ve paid your bills on time)
- Outstanding debt (whether you’re overextending your ability to repay what you borrow)
- Length of your credit history (how well established you are as a borrower)
- Types of credit you use (a mix of credit cards, installment loans, mortgage loans, etc.)
- New credit (whether you’ve recently taken on new obligations)
Credit Scores and Your Mortgage
Your credit score affects your ability to obtain future credit, whether that credit is a credit card, auto loan, or a home mortgage. If your credit score is particularly low, it indicates to a lender that you are a credit risk, and that they should either take additional precautions when lending you money, or decline to lend you money at all. In terms of a home mortgage, your credit score affects the kind of mortgage you’ll be able to obtain, and what kind of rates and fees will be attached.
- Home buyers with good credit ratings will have access to Conforming Conventional Mortgage Loans, also known as prime rate loans, or “A” loans. These mortgages have the best rate of interest a lender has available according to market conditions, and are made by for-profit lenders without insurance from the federal government.
- For buyers with low credit ratings, meanwhile, there are Subprime Loans, used by lenders when buyers cannot qualify for prime loans. These loans rely on risk-based pricing, which determine your interest rate and fees based on a complex computerized evaluation of your specific circumstances and the likelihood that you will default on, or fail to pay, your mortgage. Subprime loans have a grading system developed by lenders, which range from A- to D. The lower your credit score is, the lower grade loan you will qualify for, and a higher interest rate and fees will apply.
- While subprime loans are pricey, they are not predatory, and can be a legitimate way for someone with a low credit score to obtain home financing. However, it is a fine line, and you must shop carefully and watch out for outrageous fees and unfair terms. Also, it is important to consider other options that may be available to you, including FHA (government insured loans), USDA Rural Development loans, and Michigan State Housing Development Authority (MSDHA) loans which are specific programs for low-income or first time homebuyers.
Check out our fact sheet on bankruptcy and homeownership.
Improving Your Credit Score
Fortunately, it’s possible to improve your credit score! According to Terry Clark-Jones, MSU Extension Educator, “You can improve your credit score by always paying your bills on time, minimizing your credit card balances to below one third of the available credit, and when opening and closing credit account only open accounts when truly needed and close accounts slowly making sure not to close your longest held active credit account.”
TIP! You are entitled to a free credit report from AnnualCreditReport.com one time each year from each of the three credit reporting agencies.