Buying your first home is very exciting, but it can also be overwhelming, especially when it comes to understanding how your credit score today can impact your mortgage for years to come.

Last week, we talked about understanding your credit score. This week, we are talking about why your credit score is important.

Your credit score plays a crucial role in determining so much, including the type of home you can buy, how much you can afford, and the interest rates you’ll receive on your mortgage. So, it is essential to understand this because getting this wrong could impact you for up to 30 years!

Why Is knowing your credit score important?

Your credit score is not just a number that credit agencies pull out of the air. It’s a reflection of your financial health. Lenders, banks, and mortgage companies like Fanny Mae and Freddy Mac use this score to assess how risky it is to lend you money. A higher credit score means better mortgage options, lower interest rates, and more favorable terms when buying a home. A lower score can limit your choices, increase your costs, and lead to less favorable terms on your mortgage.

Understanding your credit score before you begin house-hunting is essential to ensure you are well-prepared for the financial commitments ahead.

What determines your credit score?

Your credit score is a “composite” score, something that is built on a range of different factors.

1. Bill-Paying History: This is one of the most important factors affecting your score. Do you pay your bills on time every time? When was the last time you missed a payment or made one late? Lenders want to know that you’ll repay the loan when you pay it. They will look at your history of making payments to see if you have a history of doing so.

2. Existing Debt: This includes credit cards, payday loans, car loans, and more. The total amount of unpaid debts can weigh heavily on your credit score. The more outstanding debts you have, and the more you owe every month, the more difficult it will be to pay for your mortgage.

3. Number and Type of Loan Accounts: The mix of credit types (e.g., loans, credit cards, and other types) and the number of accounts you have can also influence your score. If you have many different credit cards with high interest rates or several outstanding car loans, it will make it more difficult for you to repay a new loan. The fewer open loan accounts you have, the better.

4. Length of Your Loan Accounts: Generally, the longer your credit accounts have been open, the better it is for your score. Established credit history shows years of responsible credit management.

5. Credit Utilization Rate: This refers to how much of your available credit you’re using. That is, for all the open credit that you have, how much are you using? Ideally, you want to use as little credit as possible because the more you use, the more payments you make.

6. New Applications for Credit: When you apply for new credit, a hard inquiry is made, which can temporarily decrease your score. It’s essential to be mindful of how often you apply for credit. A lender will look at whether you are applying for new credit recently. If you are, they will want to know why.

7. Negative credit issues: Events like having a debt sent to collections, foreclosure, or bankruptcy will significantly impact your score. The timeframe for how long these events affect your credit varies, typically lasting seven to ten years.

Your credit score isn’t static. It fluctuates month to month, reflecting your current and past financial behavior.

For instance, opening a new credit account, like a car loan, might lower your score, but paying off a significant debt, such as a credit card, can lead to a score increase due to a higher available credit amount. Your credit score will change based on your behavior. So, if you want to improve your credit score, you must improve your behavior.

Now that you understand your credit score, you can begin to make the behavioral changes to make it better to buy your home!