Whether you’re planning on buying a house, a car, or making another large purchase, it’s important to understand the impact your credit report will have on your loan.
Lenders will determine your application for credit and creditworthiness based on the information in your credit reports, so it’s important to know what is in your credit history.
So let’s take a look at the information that your lender will be going over when considering your loan application.
1. Your payment history is a record of how well you repay debt. Derogatory information such as late payments, charge-offs, collections, repossessions, etc… lowers your credit scores and decreases your chances of being approved for a loan.
The last 6-months of your payment history impacts your credit scores more than anything else, that is why it is so important that you put together 6-months of perfect payment history before you apply for credit.
If you have derogatory information reporting in your credit reports it is important that you contact the credit bureaus and credit furnishers to improve your credit standing and increase your scores.
2. Your balance to credit limit ratio is the second most important part of your credit reports and impacts up to 30% of your FICO Scores. Maxing out your credit cards leads to a high balance to credit limit ratio (credit utilization) lowers your credit scores and makes it look like you are living off your credit cards to lenders.
Before applying for a loan, pay down your credit cards. Some credit experts will tell you to pay your balances down to 30% of the credit limits, some will tell you to pay your cards down to 20%. According to FICO, your credit utilization should be as low as possible but, not 0. FICO High Achievers, consumers with FICO Scores above 780, have an average balance to credit limit ratio of 5.8% ($58 balance for every $1,000 credit limit).
So before you apply for a loan, make sure that you pay down your credit cards as low as you can but, do not pay them completely off.
3. Your length of credit is another important factor that is used to determine your creditworthiness. The amount of time that you have had credit will help lenders gauge your credit risk. If you have a credit history with open accounts only open for a period of a few months, lenders may determine that you don’t have a long enough track record of responsible credit history to gauge your level of risk.
Before applying for a loan, make sure that your newest account has been reporting for at least 6 months and that the average age of your open accounts is at least 1 year (ideally 2 years).
So don’t close your oldest accounts, keep them active and open and grow your length of credit history.
4. Your mix of credit is another important factor lenders look at when determining your creditworthiness. There are 2 different types of accounts, revolving, and installment.
Installment accounts are accounts that have a set length of term. Auto loans, mortgages, personal loans, student loans, etc…
Revolving accounts are accounts that do not have a set term like credit cards. There is a credit limit and as you pay down your balance, your available credit revolves to the next month.
When applying for an auto loan or mortgage, your installment payment history carries more weight than your revolving payment history and when applying for credit cards, your revolving payment history impacts your application for credit more than your installment payment history.
But, don’t forget that mix of credit accounts for 10% of your credit scores so if you only have one type of account and not the other, your scores will be lower than they should.
It’s a good idea to have both installment and revolving accounts in your credit reports.
5. Finally, your previous applications for credit, also known as inquiries, will impact your credit scores and ability to get credit. There are 2 different types of inquiries, hard inquiries, and soft inquiries.
Hard inquiries are applications for credit and impact your credit scores.
Soft inquiries are a historical record of anyone, including you, checking your credit and DO NOT impact your credit scores.
Hard inquiries report on your credit reports for up to 2 years and only the last 12 months’ inquiries impact your FICO Score.
Ideally, you should not have more than 1 inquiry every 6 months (4 in 2 years).
Review the hard inquiries in your credit reports and if you see any suspicious or unauthorized inquiries you can dispute them with the credit reporting agencies and request the permissible purpose authorization from the creditors who pulled your credit reports.
If the creditors who reported the inquiries are unable to provide you with the documentation proving the inquiries were legitimate, they will remove them from your credit reports – increasing your scores, and increasing your chances of being approved for a loan.
If you need any help with reviewing your credit reports or increasing your scores by working on removing the derogatory information in your payment history, inquiries, or optimizing the factures used to calculate your scores, call us for a free consultation so CreditFirm.net can show you how we can help you improve your credit and increase your chances of being approved for a loan.