Credit Reports Explained

Before you start house hunting and getting pre-approved for a home loan , check your credit report and get your FICO scores. Why, you ask? Your credit rating may be the single most important piece of financial information you have to obtain a mortgage at the best interest rate.

Checking your credit rating before you purchase will give you time to correct reporting errors and to clean up your ratings if they are in the dumps. One lender tells us that it can take up to 90 days to get erroneous — and costly — information off your report, although some prospective homebuyers say they have a much quicker outcome.

Real Life Example

Who: Divorced woman interested in a home purchase

What: She noticed two credit cards listed on her credit report that belonged to her ex-husband. The cards were bringing down her FICO score as a result of his recent late payments.

Outcome: She used the "Dispute” feature on the Web site where she'd obtained her report in the first place and was able to get the cards removed from her report within 48 hours.

Buyer's Tip: Depending on the lender or mortgage broker, it may be possible to pursue a loan before negative items on your credit report are removed. A lender might forgive negative items such as unpaid parking tickets before they’ve been removed from your report — but only if you show evidence you’ve paid them.

FICO vs. credit report

Is your FICO score the same as your credit report? No. In addition to viewing credit reports from the three major reporting bureaus (Equifax, TransUnion , and Experian ), you also should obtain your FICO score. Your score is like a report card. Fair Isaac & Co. (the FICO score keeper) assigns you a number based on the information in your credit report. Since there are three credit-reporting bureaus, you have three FICO scores. Here are the scoring factors:

Credit Checklist

• Payment history – Have you paid your bills on time?

• Amounts owed – What is your overall debt?

• Length of credit history – How long have you been borrowing money? Lenders like to see a long credit history.

• New Credit – Have you applied for new credit?
• Types of credit used – Lenders like to see all kinds of credit types: bank cards, car loans, student loans and more.

What's an A+?

The FICO scores range from 350 to 850; an 850 is the Holy Grail of credit scores and 723 is the median score in the U.S., but you can expect good mortgage interest rates at the 720 to 760 level and up.

For anecdotal evidence of your good credit standing, if you notice you are receiving a lot of 0 percent credit card or lines of credit offers, you are probably in pretty good shape.

Homebuyers who pursue an FHA loan , one of the most common loan types for first-time purchasers, can usually secure a loan if their credit is 630 or over.

If you are applying for a "stated income” loan, whereby you forego providing income verification to the lender, the lender will be looking for a minimum FICO score of 680 or higher. Banks don’t like to assume all the risk, so your good credit history is key.

Seventy to 80 percent of mortgage lenders use FICO as their means of determining your interest rate and the types of loan you qualify for; as interest rates creep up, this difference can be significant.

Free Reports

The good news is that your credit report is easy to get. A federal regulation that went into effect September 2005 gives consumers access to one free credit report per year from each of the three reporting bureaus: Equifax, Experian, and TransUnion. The online report is generated after you answer a series of security questions and only takes about 10 minutes to complete.

Your FICO score is in easy reach as well at www.myfico.com. Each FICO score costs approximately $15, but this expense may save you thousands over the life of your mortgage if you end up with a lower interest rate.

Turning It Around

So, what do you do if your reports make you want to hide under the covers and never use your credit cards again? Relax, you can turn your ratings around.

Lenders look at the "age,” dollar amount, and payment history of your different credit lines. That means opening accounts frequently, running up your balances, and paying on time or not at all impact your credit score. Just changing one of these components of your spending behavior can positively impact your credit score.

Fixing It

Many financial experts suggest the same common sense strategies to turn your credit report around:

• Always pay your minimum balance on time. Let’s face it, credit card companies make mondo profits on you when you maintain a balance. Just make sure you send them their due each month.

• Try to reduce balances. Even throwing in an extra $20 to $50 each month will help reduce the overall debt, and paying extra looks good on your credit report.

• Don’t run up the entire balance: Having $100 left on a $10,000 line of credit doesn’t look so hot. Lenders look at the dollar amount of credit available to you and, from there, what percentage of that credit you have used. In other words, if you have a card with a $1,000 limit and you’ve spent $900 on that card, you’ve used 90% of your available credit; this looks a lot worse than having a balance of, say, $200 on the card.

• Throw away new credit card offers. Don’t apply for new cards and lines of credit right before you go home shopping. Banks will not turn a blind eye to numerous inquiries for new credit.

If bad credit continues to dog you, the FHA loan programs may be your ideal option. With down payments as low as 2 percent, Americans with good and bad credit have been getting into their first homes with these federally-insured loans since 1934.

If you are years away from buying and you just want to get an idea of your credit score, visit Bankrate.com and their FICO score estimator; answer several credit-related questions and get a quick estimate.

Related links: Can You Afford to Buy?; Home Buyers' Fearbusters; Qualifying for a Mortgage