Home ownership usually begins with figuring out how much you can afford to pay every month for a mortgage payment in addition to tax and insurance costs. If you have high credit scores from each of the three major credit reporting bureaus, you have a better chance of securing a home loan at a low interest rate. However, the simple act of applying for a loan can lower your score, so proceed with caution.
How FICO Scores Work
The Fair Isaac Company is the organization that collects and tracks consumer loan data. The three major credit bureaus, Equifax, Experian and TransUnion, assign each borrower a three-digit score that predicts risk. Higher scores mean lower risk for lenders, and if you have high scores, you'll probably get the best (lowest) interest rates for borrowing. Five factors affect the FICO score. Your on-time payment history and the amount you owe are the biggest factors and account for 65 percent of your score. The types of credit you have and how long you've been a borrower account for another 25 percent. The last category is "new credit," which is where lender inquiries come into play.
Hard Vs. Soft Inquiries
According to Kiplinger.com, applying for a credit card, auto, student or mortgage loans will affect your credit score although the drop tends to be "five points or less," according to FICO official Barry Paperno. These are called hard inquiries, which stay on your credit report for two years and affect your score for one year. If you have an existing lender that runs your credit periodically but not for new loan purposes, that's a soft inquiry. It's also a soft inquiry if you request your own credit scores. Soft inquiries do not affect credit scores.
The Consequences of Multiple Hard Inquiries
The number of hard inquiries you initiate over the course of a year directly affects your credit score. While applying for one loan such as a mortgage only minimally affects your credit, if you follow up with an auto loan application and a credit card application, you could find yourself in trouble -- meaning your credit score will drop and you'll become a riskier loan candidate, subject to higher interest rates and loan payments.
Check Your Credit Before Applying for a Mortgage
If you plan to apply for a mortgage loan, review your credit reports and scores first with each of the three bureaus. You're entitled to one free report per year from AnnualCreditReport.com. If your credit scores indicate that you're close to qualifying for a better rate, work on improving your score before you apply by paying your bills in full and on time every month so the hard inquiry won't affect your rate. MyFICO.com offers a breakdown of what scores are best, better, fair and poor.
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