Credit scores reflect your payment patterns over time, and almost all major lenders use them. So why is your credit score important? Your credit indicates to lenders how likely you are to pay back your loan. Your credit score also determines what types of loans you will have access to and the rate of interest you will pay.
Not to mention, it’s hard to buy a car or a house without credit because lenders don’t know if you’re likely to pay them back or not.
Before being approved for a loan, a lender will run a credit report to gather your credit score—which uses your credit history to score how likely you are to pay back a loan. The higher the score, the more likely you are to repay the loan.
FICO (stands for Fair Isaac Corporation, the company that invented the model) is usually the standard for credit scores, and its scores range from 350-850. FICO’s median score is 720, and anything over 740 is generally considered great credit.
To qualify for a conventional loan, you typically need a credit score of at least 620. However, the higher your score, the better your interest rates will be. Although it may seem insignificant, even a half point rate change can cost thousands in interest.
For example, on a standard 30-year fixed-rate mortgage, the monthly payment on a $300,000 loan would be $1,347 for a 3.5 percent mortgage, compared to $1,432 for a 4 percent mortgage. That’s a difference of $85 per month. To some, that might now seem like such a big deal. However, over the life of the loan, that’s a difference in interest of over $30,000.
The interest rate not only makes a difference in how much you pay, but also in how much you can afford. With a lower interest rate, you will be able to spend less on interest, and more on your principal payments (payments towards the house and not towards interest.)
Mortgage lending is a risky process. Because of this, lenders will increase the cost of your mortgage based on every risk associated with your application.
A low credit score is risky, because the borrower has a history of making late or no payments.
Therefore, the borrower will have higher interest rate on your loan to protect the lender from any losses should you default on your loan.
If you’ve got bad credit, you’ll want to improve it before applying for a loan.
When it comes to credit, there are no quick fixes—only time and diligence can get your score back in order.
Here are five tips to get your credit score back on track:
- Make all your payments on time. Because payment history is the basis for the majority of your credit score, it is critical that all bills are paid on time.
- Your credit utilization is important, so keep your balances low. Keeping your balance low shows lenders that you can responsibly manage your credit without spending beyond your means, you should also avoid opening too many lines of credit in a short period of time, because this will suggest to lenders that you’re in financial trouble.
- Don’t close existing accounts in hopes that it will higher your score or disappear from your credit report. Older accounts will help boost your credit score, so instead of closing an account, keep your utilization low and pay bills on time.
- Always dispute mistakes on your credit report immediately. If you spot a mistake on your credit report, it should immediately be reported. Under the Fair Credit Reporting Act, credit reporting companies are obligated to fix any mistakes on your report. To report the mistake, you must submit any inaccuracies in writing to each credit bureau.
- Create positive credit history. Although you may be denied some forms of credit history, it is possible to open a new form of credit that you help you build your score. One option is to ask a family member or friend to cosign for a credit card or car loan. Another option is to apply for a secured credit card. Secured credit cards require cash collateral that will serve as a security for your line of credit.
Information provided by TowneBank Mortgage.