What's So Important about Your Credit Score?

If you’ve bought a house in the past, you probably know why your credit score is such a fundamentally important element of the home buying process. But if you haven’t owned a home before – and you’re in the market to buy one in the future – it’s vital to know how your credit standing can affect your ability to purchase the type of home you want. But before I discuss the importance of your credit score, here’s little background on the financial side of buying a new home.

When you make a plan to buy a home, one of the first steps you should take is to contact a lender. Your lender might be a bank, credit union, or other institution specializing in mortgage loans. Partnering with a lender at the outset of the home buying process is important because it will allow you to secure an educated estimate of your borrowing power, which will guide your home search toward homes that you can afford.

Lenders can provide two kinds of estimates of your buying power. One is called a pre-qualification, and the other is a pre-approval. A pre-qualification is merely a loose estimate of what you might be able to afford given some basic financial information that you provide your lender. A pre-approval is a firmer guarantee of what you can afford and is based on a more studied assessment of your financial picture, during which your financial information is actually run through the loan underwriting process. Having a pre-approval letter in hand when you make an offer on a house can show a strong level of commitment to the seller and it also puts you in a more comfortable position of being fairly certain that you will have the financing you need when you need it.

So, let’s go back to that all-important notion of credit score. Your credit rating is calculated by three major credit reporting agencies: TransUnion, Experian, and Equifax. These agencies base their assessment of your credit on your credit history. It takes the form of a number between 300 and 850. A number on the high end of the scale indicates to a lender that you are a good risk to pay off your mortgage loan. A number toward the lower end of the scale could spell disappointment when you apply for that loan.

Your credit history is based on a number of factors, such as the length of your credit history (how long you have been paying off creditors); whether you have been late on scheduled payments or missed them altogether; whether you have ever defaulted on a loan or line of credit; and even the number of lines of credit, such as credit cards, that you have open. An undue number of inquiries into your credit within a certain period of time can also affect your credit rating.

Your lender will run your credit when you apply for a loan, and your credit report will be a large part of whether your lender decides to extend you a loan and in what amount. It can also have a tremendous impact on the interest rate your lender will offer you. A low credit score often means a less attractive interest rate.

Fortunately, everyone is entitled to one free credit report each year. It is important to check on the state of your credit annually and make sure it seems to be in line with your spending and payment habits. If you notice a discrepancy, you should contact the creditor in question and find out the problem. Rectifying an unfair credit blemish will also involve the agency whose rating reflects the problem. Keeping a squeaky-clean credit standing is your best asset when it comes to securing favorable home financing, so if you’re thinking about buying a new home in the future, ensuring healthy credit goes a long way toward making that dream come true.