Credit can be a wonderful thing, but, too much of a good thing can backfire on you. For prospective homeowners, loan approval relies more on your history of debt repayment than on your income or savings.
How do you know if your credit history is healthy? Don’t rely on guesswork. Order a copy of your credit record, preferably three months before applying for a loan. You’ll see where you stand and have time to clear up any errors which may appear in your credit records.
How is credit risk measured? In today’s lending market, most credit reports are automated, relying on a credit “scoring” system that analyzes about 100 variables to gauge the likelihood that the borrower will make on-time payments.
The information measured is gathered from retailers, public records, and sometimes credit applications and bank records. The score analyzes patterns over time, with more recent payment and debt habits holding greater weight.
In the scoring system used by Fair, Isaac—the originators of scoring software—the main criteria and their approximate percentage of importance are:
- Payment history (35%)
- Amounts owed (30%)
- Length of credit history (15%)
- New credit—a warning of taking on too much debt (10%)
- Types of credit in use (10%)
Lenders use these credit scores, which range from 400 to 900 points, along with information such as the stability of your income, your employment history, and the value of any collateral and liquid assets, to determine your credit risk.
These tips will help you maintain a health credit history:
- Open an account. You must have a credit account for at least 6 months to have a credit history.
- Don’t go crazy on credit. Don’t rush out and open multiple accounts just to raise your credit. It could be considered risky behavior.
- Pay down before saving up. Make a habit of paying your bills on time or preferably in full. Lots of saving may help you with a down payment but if your credit history is questionable that savings may not matter.
- Minimize credit checks. You may be red flagged if you are running credit checks with car companies, banks, etc multiple times a year.
- Don’t take it to the limit. Lenders are wary of too many credit cards but a maxed out credit card makes it look like you are overextended.
Hold off on purchasing big “toys”. Lenders like low debt, so unless yours is very low, hold off on charging a car, a boat, appliances, or large furniture until after you’ve closed on a new house.