Do you know your credit score? The answer to this question for many people is no, but if you are planning to make a big purchase, such as a home or a vehicle, in the near future, you need to know what your score is.
What Do Credit Scores Mean?
Your credit score is a number between 300 and 850 that tells potential lenders about your creditworthiness as a borrower; in other words, how likely it is that you will be able to pay back a loan. It can be a significant factor in determining whether or not you are even approved for a loan, and also determining what your interest rate will be. The algorithm that calculates your score takes into account:
- Your history of payments on previous loans or credit accounts
- How much you currently owe on all credit/loan accounts
- How long your credit history goes back
- How much new credit you have taken out recently
- The types of credit that you use
Generally your payment history and the amounts owed are the factors that weigh most heavily on your score, accounting for about two-thirds of your total score for FICO credit calculations (the most commonly used). The other three do impact your score, though not as much overall.
The Impact on Your Mortgage
A mortgage is likely the biggest loan you will ever get, so having a good interest rate could save you tens of thousands of dollars over the course of a 30-year loan, and a higher credit score is the way to get that better interest rate. Even a drop of 50 points in your credit score from 750 to 700 could raise your interest rates by 1 percent or more. It might not sounds like that big of a difference, but that will increase your payment by about $120 a month on a $200,000 loan, and it will translate to over $42,500 in additional interest paid over the course of a 30-year loan.
Getting Your Loan
Your credit score also impacts your ability to get approved for a loan. Most lenders will not typically provide home mortgages for people with FICO scores below 620, and if you do manage to get approved, you will likely have an interest rate much higher than you would if your score were even 100 points higher.
Improving Your Credit Score
It’s best to check your credit score well before you are planning to purchase a home—that way you will have time to improve your score if needed, or correct any errors you find on your credit report that are bringing your score down. One free credit report is available each year from Equifax, Experian, and TransUnion, so download those and go through them carefully to inspect all accounts. If all the information is correct, start paying down your balances, make sure you’re making payments on time on all your accounts and loans (including vehicles, student loans, and revolving credit), don’t open any unnecessary new credit lines, and your score should improve over time.