Home loans explained
How credit scores affect your home loan application
8 min read
Learn everything you need to know about credit scores. What affects them, and what you can do to improve yours.
When you apply for a home loan, your credit score gives your potential lender information about what kind of borrower you are likely to be based on your credit history. Your credit score is based on your credit history which is a report on the various credit accounts or debts that you have had. It also shows your repayment history and whether you’ve had any defaults or missed repayments. All this information is analysed and converted into a credit score which is used by lenders to help assess your application when you apply for credit (personal loans, credit cards, home loans etc.). A high credit score means you have a good repayment history and a manageable amount of debt; while a low credit score can mean you’ve missed repayments or have too much debt already to take on any more.
A record of your personal credit history (your debt repayments and defaults), used by credit reporters to determine your credit score.
A number that represents your risk of future defaults based on your credit history. This number helps lenders assess whether you can borrow money and how much you can borrow.
Tic:Toc uses two credit reporters (Equifax and Illion) to obtain credit histories. An Equifax credit score is between 0-1200 and an Illion credit score is between 0-1000. In both cases the higher the number, the better your score.
It seems obvious, but the largest part of your credit score is whether you can repay the funds that have been loaned to you. Things like paying your bills on time (or late), debt collections, bankruptcies, foreclosures and the time between each negative event are all considered in this part.
Making your repayments isn’t enough to get a good credit score, the amount of debt you already have also impacts your score. Credit reporters will consider how much of the available credit you’ve used, how much you owe on specific types of credit (mortgage, credit cards, car loans etc.), and how much you owe in total. You don’t have to have everything at $0 to get a good score, but the lower the amount the better.
A long (late payment free) credit history can help you in the credit score department. It shows you have a long history of making your repayments on time and managing your credit accounts responsibly. However, a short history doesn’t necessarily equal a bad score. As long as you’ve made your payments on time and don’t owe too much, you should be fine.
How recently you’ve applied for new credit is also considered when calculating your credit score. Taking on a lot of new debt in a short time can suggest you’re having some cashflow problems, which may make lenders less willing to lend to you.
When it comes to credit, there are two basic types, revolving accounts and instalment loans:
Revolving accounts let you borrow funds repeatedly up to a maximum amount. They don’t have a specified end date and can remain open as long as you continue making your minimum repayments. You normally have a choice to repay any amount between the minimum repayment amount and the full balance of the account. If the full balance of the account isn’t paid at the end of the billing period, the remaining balance is rolled over into the next one and interest is charged on this amount.
Examples of revolving accounts: credit cards, utilities, and mobile phone plans.
Installment loans are set amounts of credit that are repaid over time with a scheduled number of repayments. The loan has a set term length anywhere from a few months to 30 years, during this time you make fixed repayments at scheduled frequencies.
Examples of instalment loans: home loans, car loans, and personal loans.
Each time you apply for a loan the lender will make an enquiry on your credit report which shows that you’ve applied for credit, this is known as a “hard” enquiry. One or two of these won’t hurt your score too much, but you should try to keep them to a minimum (so don’t go crazy and apply with every lender out there). Only the last 12 months of enquiries are used when calculating your credit score, and after 24 months they disappear completely from your record. The good news is that checking on your own credit report is considered a “soft” enquiry, and they don’t impact your credit score. So you can make sure your credit report is healthy and accurate before you apply.
Below average to average (0-509): You are more likely to have an adverse event recorded on your credit report in the next year.
Average (510-621): You are somewhat likely to have an adverse event recorded on your credit report in the next year.
Good (622-725): Adverse events will be less likely for you in the next year.
Very good (726-832): You are unlikely to have an adverse event recorded on your credit report in the next year.
Excellent (833-1200): An adverse event is highly unlikely to happen to you within the next year. (Hint: this is what you’re aiming for).
Your credit score gives your lender the information they need in order to work out what kind of borrower you will be. If you have a high credit score, you will likely have more home loan options available to you (including lower interest rates). An average credit rating will see you with less options and possibly higher interest rates (aka risk-based pricing, but that’s a topic for another day). And a low credit rating may mean that you aren’t able to get approved for a home loan at all.
If your credit score isn’t as high as you’d like, there are lenders who specialise in home loans designed for people who have adverse credit histories.
While there are options out there if you have a lower credit score, it’s still a good idea to keep your score as high as possible. There are several things you can do to make sure your credit score is as healthy as possible:
It’s a good idea to order a copy of your credit report to check for incorrect information. You should look out for incorrect personal information, repeated or inaccurate debt amounts, incorrect credit defaults, current outstanding debts and any debts that were created in error. If your history has any incorrect information you can contact the lender directly to have them remove it.
Enquiring about your own credit history is considered a soft Enquiry so you don’t have to worry about it negatively affecting your score. You can request a free copy of your credit history through Equifax or Illion.
If you haven’t had any credit accounts, you may have a ‘lighter’ or ‘thin’ credit history, however lenders may still be able to gauge your credit worthiness based on telco and utility accounts under your name.
Credit reporters don’t just look at the amount of debt you currently have to pay back, they also look at the amount of credit that is available to you. For example, if you have a credit card with a $10,000 limit even though you may not owe anything on that credit card, you are still considered to have $10,000 of credit available to you. If you want to improve your credit score, lowering your credit card limit right down to the minimum can help, so consider changing that $10,000 credit card into a $3,000 credit card.
If you have multiple loans, consolidating them into one loan can help improve your credit score. Consolidating loans turns several repayments into one manageable repayment and can save you money if you’re able to refinance to a lower interest rate. Likewise, combining multiple credit cards into one card can also help your credit score. Having just one credit card lowers the amount of credit you have available to you and is a single credit account on your record as opposed to multiple.
This one is straightforward, making your repayments on time is the best way to ensure that you don’t have any defaults on your record. A default is when you’ve had an overdue payment valued over $150 for 60 days or more, they stay on your credit report for 5 years.
When applying for any kind of credit, the lender will request to review your credit report, and this is recorded in your history. Too many hard enquiries can negatively affect your credit score, so if your application is rejected, wait a bit before you apply again.
If you apply for credit right before you apply for a home loan you are adding to the number of hard enquiries on your credit history. You are also increasing the amount of debt that you have which could negatively impact your score.
There’s no time like the present to get your credit history in check. If you’re thinking of applying for a home loan, consider requesting a copy of your credit report and checking for incorrect information. A healthy credit score can help make your home ownership dreams come true.