Credit and How It Works
Credit is one of the main components lenders will utilize to qualify borrowers for most types of financing such as mortgages, cars, or credit cards. Once you have enough credit established, credit scores are generated based on your payment history. Higher scores are a result of timely payments, and lower scores result from late or missed payments. The higher your credit score, the more likely it is to get approved for a loan with more favorable terms. For mortgages, higher credit scores can qualify for lower down payment options and lower interest rates whereas for lower credit scores, the opposite is true.
Typically, lenders prefer to see 12 to 24 months of payments to one or more major credit providers such as a mortgage, car loan/lease, Visa, or MasterCard. Store credit cards will carry less weight. If you are new to establishing a credit rating, you may want to start applying for credit with a major credit provider such as a Visa or Discover Card. Initially, your credit limits may be lower, but they will gradually increase over time with a good payment history. In some cases, a creditor may request you add a co-signer or co-borrower if you don’t have a lot of established credit.
Additional components included on a credit report that can have an adverse effect are:
Public records: This area will report public items such as bankruptcies, foreclosures, or tax liens.
Collection accounts: The most common collections are medical bills or other bills that a bill collector or creditor can place on your report for past due payments.
Charge offs: These will occur for credit cards that have fallen beyond the window of repayment. The remaining balance will show as an arrearage which will adversely affect your credit and your scores.
Credit inquiries: Inquires pulled in a certain timeframe usually won’t hurt your credit score, however, multiple inquires over longer periods of time could affect your credit. Excessive inquiries can cause a red flag for lenders looking to provide financing for you.
Bottom line: Establishing a credit history is not hard, but it takes a little time to build. Start with one or two credit cards, make timely payments, and build from there.
Source: Mortgage Market Guide