Buyers, both first-time and seasoned, seem to have more questions about credit than any other subject related to financing. Because credit plays an increasingly more important role in the qualification process, it also becomes more important for you to be able to understand your credit score.
A “credit score” is actually the middle score assigned by the three credit bureaus: Trans Union, Experian, and Equifax. These companies collect credit information for credit scoring models and report this information to mortgage lenders and others who request it when consumers apply for new credit.
There are many components that make up a credit score, each with a different impact. Two of these components are of uppermost importance to your buyers as mortgage consumers. These are: recent payment history and balance-to-limit ratios.
Recent payment history tells potential lenders whether the person requesting a mortgage can manage the debt they have. This provides lenders with a decision-making tool to decide if the potential borrower is able to take on more debt.
Balance-to-limit ratios indicate the status of credit card balances as compared to the cards’ limits. Even if you are making their payments on time, they still may be over-extended; ideally a balance will be 30 percent or less than the cards’ limits.
Collections and judgments
Collections and judgments are also hugely important. Collections, even small ones, can drop credit scores significantly. It’s important to be aware that older, smaller collections may best be left alone, as paying them off in the course of obtaining a mortgage may have more of an adverse effect in the short term. Smaller collections likely won’t need to be paid off.
Judgments need to be paid off either at or before closing, or proof must be provided that some type of payment arrangement has been put in place and followed for at least 12 months. Tax liens always need to be paid off before closing, as they will stand in front of mortgage liens in the event that the buyer defaults on the mortgage they are applying for.
Short sales and foreclosures
As per recent changes in FHA guidelines, previous short sales and foreclosures may be less of an issue for buyers who otherwise have decent credit profiles. The Back to Work program allows a qualified buyer who can document a drop in income or a loss of income that resulted in the loss of a home to potentially qualify for the purchase of a new home after 12 months.
If you plan on financing a home, you may want to sit down and figure out where you are with regard to those credit issues noted above, and if need be, pay down credit card debt and/or make sure that you are paying your bills on time.
Credit bureaus can take up to 30 days to report credit information; you may want to make changes before you apply for a mortgage so these changes are reflected on the application.