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Lesson 2.1

What is Credit, and Why Is It Important?

 
Tim Alvis | Credit Expert | NMLS #373984

A Credit Score is a Tool

A credit score is a tool. At its heart, it reflects your willingness and ability to repay debt.

Whether it’s a mortgage lender, a car dealer or even a department store, anyone who’s thinking about extending credit to you is taking a risk. They’re giving you the opportunity to purchase something today and pay for it tomorrow.

Creditors and lenders want to do whatever they can to hedge that risk and make sure you’re a safe bet – that you’re someone who’s likely to fulfill their obligations and repay that money on time every month.

Credit & Borrowing Costs

A credit score allows lenders to make an instant judgment about your ability to repay debt. The higher your score, the more likely you are to pay back that money on time every month. Or that’s at least how lenders and creditors tend to look at it.

People with higher scores have shown over time that they can handle credit responsibly. And that’s really important, because your credit score comes into play with so many financial needs, such as home loans, car loans, student loans, business loans and more. Even landlords in some parts of the country run a credit check with your rental application.

But it’s not just about showing lenders you’re a safe bet. Your credit score can also play a big role in determining what it costs to borrow that money. Generally speaking, with home loans, people with higher credit scores can tap into lower interest rates. That can save you thousands of dollars over 15 or 30 years.

So how do you get a credit score?

Credit Scoring

There are three major credit reporting agencies: Equifax, Experian and TransUnion. You’ll sometimes hear them called the Big Three. Many of the lenders that offer you credit will turn around and report how you use it to one, two or all three of these credit reporting companies. And it’s at the Big Three where your credit history and your credit score take shape.

Generally, things like your payment history, your amounts owed, your length of credit history and more can all affect your score, for both good and bad. Paying your bills on time every month and keeping a healthy balance of debt in relation to available credit can boost your credit profile. Negative events like late payments, bankruptcies, foreclosures and collections can hurt your score and even force you to put your homebuying plans on hold.

Because not all creditors report to all three credit bureaus, you may have a different credit profile at each. What can be even more confusing for consumers is you don’t have just one credit score. In fact, there are dozens and dozens of credit scores out there.

But when we talk about VA home loans and the mortgage industry as a whole, we’re usually talking about one type of credit score in particular. That’s called the FICO score, which falls on a range from 300 to 850.

The FICO score relies on your credit information from each of the three credit bureaus. FICO uses sophisticated modeling and software to create scores for specific forms of borrowing, including car loans, credit cards and mortgages. Each of the three credit bureaus can use a slightly different FICO scoring formula to create your score.

That’s a big reason why lenders will pull your mortgage-focused credit scores from all three credit bureaus and use the middle, or median, score as your credit score. It’s also why consumers often see different credit scores than what lenders see.

When you purchase or otherwise get a look at your credit scores from FICO or other agencies, you’re typically seeing a broad-based “educational” score. That’s a more basic credit score, and it’s often different from the industry-specific scores mortgage lenders will see.

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Credit Score Requirements

Most VA lenders will have a minimum credit score requirement. These benchmarks can vary depending on the lender and other factors. We’ll talk in more detail later about where you need to fall on that range for VA loans and other types of home financing.

For would-be VA buyers, the good news is that it’s usually a lower score than what you would need for a conventional loan (and considerably lower than what you’d need to have a shot at the best rates and terms on conventional loans).

But even a lower credit score benchmark can be tough for some veterans and active military. That’s why it’s so important to get a good handle on your credit before you start this journey.