Jan. 13, 2018
Another month, another rent payment that’s helping your landlord pay off the house or apartment where you’re living. Another month, another rent day spent pondering just how much equity you could have paid down on your own house by now. So, why not you? Why not now? Sure, buying a house can be complicated and intimidating, knowing some of the pieces of the puzzle goes a long way towards getting there.
Let's back up, to before you started looking online and got frustrated. I it’s important to fill in some informational blanks. For example, do you know what a FICO score is or truly understand how it affects your ability to get a mortgage? A lot of first time homebuyers often need to do some work on their credit accounts, which isn't such a bad thing. So, it’s a good idea to start looking into this stuff six months to a year before you bite the bullet and make a loan application.
We're gonna get as basic as it gets with the FICO score.
Fair Isaac Really Isn’t Judging You, Mostly.
Back in ancient times, the 1950s, getting credit was a whole different kind of thing. Rates and down payments or securities were high, terms were short and credit was not nearly as widespread as it is today. Then two fellows named Bill Fair and Earl Isaac came along. They believed that there had to be a better way to make business decisions using data and computer algorithms (a bit ahead of their time, eh?), successfully completing the first credit scoring system in 1958.
By 1970, the Fair Isaac Company was delivering scoring systems for bank credit cards, then in 1981, it developed the credit bureau risk score — similar to the one your bank will be using to determine if you’re going to get a mortgage. The secret proprietary algorithm has been updated throughout the years in a quest to develop the most accurate picture possible of potential borrowers based on their past behavior.
Your FICO score isn’t a judgement of your character, of your job or anything like that. A lot of people attach the two, so it's important to understand that point. It’s simply a number that tells lenders how likely you are to be willing and able to pay back credit over the long run. If you’ve never had credit or not had much credit experience, expect your number to be lower simply because there’s no data on you. If you’ve had some credit, maybe a student loan or a car loan, and always paid on time, you’re probably golden.
A score of 620 is serviceable, a 650 is generally enough to get a mortgage.
What’s in a FICO Score?
A lot of people are confused about what exactly gets figured into a FICO score. FICO is just an algorithm, remember, so there’s nothing that it can calculate without being fed data. So, the score is based on the information from whatever credit bureau that you’re using to request a FICO score. Nothing else. Things like your on-time utility payments or car insurance, for example, don’t tend to report, so they won’t be added into the calculation.
When shopping for a pre-mortgage score, it’s best to look for a tri-merge report, or a product that gives you scores from all three bureaus: TransUnion, Experian and Equifax. This is exactly what your bank will do to qualify you. MyFICO.com offers this service and you’ll get scores directly from the horse’s mouth, but feel free to use whatever tool works for you. There are plenty of legit sources out there that can approximate your FICO score.
The main factors that influence that score are probably exactly what you’d expect. They’re bits and pieces that are telling about your credit usage and ability to repay. FICO’s own site lists these as the primary components and weights of an average borrower’s score:
Payment History (35 percent). If you don’t make your payments on time, the credit bureaus report that and FICO makes a note. Non-payments, late payments and the like don’t report until they’re 30 days past due, but it’s still good practice to pay on or before the due date. If you’ve had late pays in the past, just keep paying on time now. The more space you put between today and those late pays, the less they’ll affect you.
Amounts Owed (30 percent). Are your credit cards maxed out? … like, every month…? Well, this is something you need to get a handle on. This metric looks at not only how much you owe, but how much you owe in relation to how much credit you have. The magic number for utilization is a meager 30 percent. If you’re trying to establish credit, it can be a tricky thing to keep your usage under 30 percent, but above zero to prove you can maintain payments long term.
Length of Credit History (15 percent). The age of your credit accounts, as well as the average age is considered under this metric. FICO looks at both opened dates and the date of last utilization to figure out your risk here. To even be in the running for a bronze medal, you need an average credit line age of over two years, but people with extremely good credit scores may have credit histories of 25 years or more.
New Credit (10 percent). FICO wants to see if you’ve recently acquired a bunch of new credit, maybe in anticipation of charging everything up and fleeing to Canada. Experience has told them that suddenly opening several new accounts in a flurry means that you’re a big time risk for default.
Credit Mix (10 percent). Did you know this was even part of it? Do you only have store credit cards, or do you also have a car loan and a student loan? The better the variety in your credit history, generally the better risk you represent. Don’t run out and get a bunch of different loans just to see how it shakes out, but if you just have a car loan, it won’t hurt to get a small credit card through your bank just for emergencies.
Improving Your Credit for Beginners
Now that you know what the FICO algorithm considers when it calculates your score, you can use this information to improve your credit score before you apply for a mortgage. Be patient, though, it takes time to see these kinds of changes manifest.
Start by going to AnnualCreditReport.com and requesting your free credit reports (you’re entitled to a set of free credit reports from this site once a year). Check them thoroughly for errors of any sort. Dispute, dispute, dispute. Many credit files have some kind of errors on them. Don't use the others, this is the only one approved by the US Government.
While the credit bureaus are working on your disputes, you can start to pay off any judgements that appear on your credit reports, as well as developing a plan to pay each and every future payment on time. If your checks come on a regular schedule, autopay isn’t a totally bad option, but if you’re part of the gig economy, of course, that’s probably not going to help.
With each payment, your credit will start to improve. Leave those credit cards alone. Just put one payment in front of the other, and before you know it, you’ll have beautiful credit. Super extraordinary stuff. There’s no real secret to it, it’s all just perseverance.
If you think you might need some help doing the research or coming up with a plan to take care of any credit issues you discover, there are some very reputable credit repair companies out there. We can refer you to some that our preferred lenders recommend, and some of our clients have used successfully.
Now that you’ve got your credit as good as it can get, ask your real estate agent (hi there!) to provide some lender referrals, and set up an appointment for a pre-qualification. This is where a lot of you stop.
Don't. Again, not as scary as it seems. Take a copy of your taxes for the last two years and your ID to help get the ball rolling. If that seems too intimidating, you can start with a casual phone call to discuss your situation. Lenders are your friend, and we are all together as a team pulling for you!
This is part of what we'll be covering in our online course Six Months to Home. All free, all self-paced. Sign up here and let's get you home!