Why Do Lenders Need My Credit Report And Score?
If you’re applying for a loan, it makes perfect sense to shop around and see where you can get the best terms. When you call a lender though, they’ll likely want to pull your credit to get a look at your report and score before giving you rate information.
The aim of this post is to help you understand why lenders are interested in your credit and what they’re looking for, as well as debunk a few myths around the impact of credit inquiries on your overall score.
Why Do Lenders Pull Your Credit?
Whether you’re doing something as small as applying for a store credit card or as big as securing a loan for a home, lenders have to judge your creditworthiness. You can think of it as a judgment of how likely you are to be able to make the payments on the line of credit or the loan.
In the days before financial institutions shared information with credit bureaus, the bank may have had nothing to go on in making credit decisions besides any past loans it may have personally given you or other subjective instincts like looking at the kind of clothing you were wearing.
The good news is it’s no longer like that. Instead, now we have three credit bureaus – Experian, Equifax and TransUnion®. Lenders report information to these bureaus in order to keep an accurate track of your history with credit.
In 1989, Fair Isaac Corporation developed the FICO® Score to quantify information in your credit record.. There are various models that exist, but typically, when lenders look at your credit, they’re looking at one of the models from FICO®.
When lenders pull your credit, they look at both the information on your report and your FICO® Score. This helps them get an idea of your credit record, which impacts not only whether you’re approved, but also the types of rates and terms you can get. Those with the best credit qualify for the best offers.
What Do Lenders Look For When Your Credit Is Pulled?
When lenders pull your credit, they’re looking for two things: your debt-to-income ratio (DTI) and your credit score. Let’s briefly talk about both of these.
Debt-to-income ratio (DTI)
DTI is a ratio comparing your monthly income to your monthly revolving and installment debt payments. This includes loans, but it can also include things like child support and alimony. The formula is simple and it works as follows:
Installment debts include things like car payments, personal loans, student loans and mortgages. Revolving debts are credit cards and other lines of credit where the payment changes based on usage.
Let’s run through a quick example:
Your income is $5,000 per month. If you have a $1,100 mortgage payment, a $400 car payment, a $500 personal loan payment and $100 worth of minimum credit card payments between a couple of accounts, your total debts are $2,100. When you put those numbers into our formula ($2,100/$5,000= 0.42), your DTI is 42%.
For the purposes of calculating DTI, your minimum credit card payment is used.
Although what you need for qualification will depend on the type of loan you’re getting and the investor, for the purposes of a mortgage, our friends at Quicken Loans® recommend maintaining a DTI of around 43% or lower in order to qualify for the most possible mortgage options.
A last important note is that not every item that you pay a bill for shows up on your credit report. Typically, this is limited to loans and lines of credit. However, you don’t want other accounts like memberships, utilities and cable bills to go delinquent. At that point, they can show up on your credit report in the form of collections or charge-offs which can hurt your credit score.
The other piece that lenders get when they pull your credit, in addition to looking at your credit report, is your credit score. Although the score can vary depending on which FICO® model is being used, they do make public the general breakdown of how your score is calculated.
- Payment history (35%): The biggest factor in your credit score is simply whether you make your monthly payments on time in at least the minimum amounts. Late payments hurt your score while a history of on-time payments will help.
- Debt owed (30%): This takes a look at the amount of debt you have. It includes installment payments on monthly debts, but those don’t change much on a monthly basis. What you can change on a monthly basis is your credit utilization. Your credit utilization is the balance you have on your credit cards divided by your combined credit limit between accounts. If you charge $2,000 worth of items per month and have a $10,000 combined credit limit, you have a credit utilization of 20%. The lower this figure is, the better. We’ll explain why below.
- Age of credit (15%): This is based on the age of your oldest active account. The idea here is that the longer you’ve had credit, the more lenders can be confident in the history.
- Credit mix (10%): Lenders want to see a mix of both installment and revolving debts so that they can see your history of responsibly handling payments on different types of loans.
- New inquiries (10%): New credit inquiries will temporarily lower your score slightly. The reasoning is that if you take out new credit, lenders are sometimes concerned that you might be overextending yourself. If you’re shopping around for the best rate on a mortgage, auto or student loan, this works a little bit differently. We’ll get into that below.
Another thing to know is that when lenders look at your credit score, they usually get scores from all three major credit bureaus. The score that counts for qualification purposes is the lowest median FICO® Score of all clients on the loan.
If your credit score places you on the edge of qualification, there are other measures that may be taken into account. This includes the amount of debt you have that’s related to housing expenses as compared to your monthly income.
One of the things mortgage investor Fannie Mae specifically looks at is trended credit. If you’re on the edge of approval as far as DTI and credit score, they’ll look at your credit utilization. If you routinely make the minimum payment, you’re less likely to be approved than someone who makes a much more substantial payment or fully pays off the balance each month.
It’s very important that you’re aware of what kind of shape your credit is in. You can get your free VantageScore 3.0® credit score and report from TransUnion® every week with Rocket HQSM. While the formula isn’t quite the same as FICO®, they’re very similar. The additional advantage is that you’ll get educated on what you can do to improve your score.
If you find your score isn’t quite where you want or need it, check out this resource on raising your credit score fast.
Understanding The Credit Pull Process
People have some misconceptions about the credit pull process that can make them hesitate when applying for loans. This is understandable, but this section will separate truths and falsehoods to help you gain a better understanding of the full picture.
What’s The Difference Between A Hard And Soft Credit Pull?
The first thing to understand is that there are two types of credit pulls: hard and soft.
A hard credit pull is done when you officially apply for a new loan or line of credit. A hard credit pull will temporarily lower your score. FICO® says the drop could be under five points if you have a longer credit history, while there will be a greater impact if your history is less extensive.
A soft credit pull is reserved for things that aren’t related to official loan applications. This includes checking your credit score on sites like Rocket HQSM. Soft pulls are also utilized for things like pre-employment credit checks and when companies send you unsolicited loan and credit offers in order to advertise their services. A soft pull has no impact on your credit score.
What Triggers A Hard Credit Inquiry?
A hard credit inquiry occurs when you officially apply for a new loan or line of credit. Not every application causes a hard inquiry. Let’s go over the exception.
What Happens If You’re Shopping Around For The Best Rate?
When you apply at various lenders looking for the best rate, they’ll need to pull your credit. Fortunately, FICO® has carved out an exception for auto and student loans as well as mortgages, as these are areas where people typically shop around.
Any inquiries you make for these types of loans will count as one inquiry for that loan type as long as it’s made within the same 30-day period. So multiple inquiries won’t hurt your score if you complete them within a reasonable timeframe.
How Often Do Lenders Pull Your Credit During The Mortgage Process?
For most loans, your credit is only pulled once. Because a mortgage is a more complicated financial transaction, sometimes credit is pulled more than once. This only occurs in limited situations.
When you receive a mortgage approval, they’re good for a certain amount of time before your credit has to be re-evaluated to make sure your situation hasn’t changed. At Quicken Loans, mortgage approvals are good for 90 days.
There are other situations in which your credit might be looked at again. These include going from having two people on a loan back to having just one person. This would be done to make sure you still have enough income to afford the loan without the other person. Finally, your credit may be re-pulled if your situation changes, such as having a negative inquiry taken off your report.
How Long Does It Take For Your Credit Score To Recover From A Hard Pull?
Experian says that hard credit inquiries remain on your credit report for 2 years but only affect your score for a year. The trouble comes if you open too many accounts or get too many loans at once.
It’s also worth noting that it’s possible to raise your credit score back to where it was in a matter of months by doing the right things like making on-time payments and carefully controlling your credit utilization. This is the case if you have a single new inquiry.
Our friends at Rocket Mortgage® by Quicken Loans can help you buy a home or refinance your current one today. You can also feel free to call one of their Home Loan Experts at (800) 769-6133.
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