Your credit score is one of the first things lenders look at whether you are applying for a conventional, FHA, VA, or USDA loan. For that reason, you should understand what your credit score is made of and why you need to worry about it when you apply for a conventional loan. Generally, credit scores are comprised of 5 different parts, but the largest two that you need to worry yourself with include:
- Payment History
- Amount Owed
The payment history on your credit report is the most important component of your credit report. In fact, it makes up 35 percent of your credit score. This is the part of the score that is tied into how many late payments you have. The most recent late payments affect your score the most, but every late payment negatively affects the bottom line. In general, late payments remain on your credit report for up to seven years as seven years is the statute of limitations, which means they can no longer report after that length of time. Your most current payment history with each lender will be reported as follows:
- Paid as agreed
- Up to 30 days past due
- Between 31 and 60 days past due
- Between 61 and 90 days past due
- Sent to collections
- Not being used
- Account in payment agreement or bankruptcy
- Charged off account
The most recent status will report on the credit report. For example, if you are 33 days late on an installment loan, the current status will report that it is between 31 and 60 days past due. If you catch up on the payments and end up current on that payment, it will then report paid as agreed on the next month, but the 60 day late will continue to report for the next seven years, affecting your credit score accordingly. The more time that passes since the delinquent payment, the less it affects your score, but it does not completely diminish for 7 years.
The amount you owe on each of your accounts plays an important role in your credit score as well. It is not so much the fact that you owe money, that is a given; it is the amount of money that you owe compared to your available credit that matters. Take into consideration the following scenarios:
- Your credit limit on a revolving credit account is $1,000 and you have $899 outstanding. In the eyes of any new lender, this is a large amount of money and shows that you tend to overextend yourself financially.
- You have a credit limit of $1,000 and you have $200 outstanding. In the eyes of the new lender, you are responsible with your available credit. You do not overspend and you keep your credit at a level that you are comfortable with paying it back.
Between those two scenarios, the person that has only $200 outstanding will have the higher credit score based on credit utilization alone. Since this component of the credit score is 35 percent of the score, it can greatly impact your score, and your ability to get a conventional loan. In general, high balances on revolving accounts have a higher impact on your credit score than high balances on an installment loan since on an installment loan, you are given the total amount; you are not able to use, repay, and reuse the credit given. If, however, overall you have a large number of accounts with a balance, your credit score will be negatively impacted.
While you need to focus on every aspect of your credit score, the payment history and the utilization rate are the two components that you need to worry about the most. By making your payments on time and keeping the amount of credit you have outstanding in check, you maximize your chances of having a higher credit score that enables you to be a good candidate for a conventional loan.