Understanding your credit score for home loans

What is a credit score?

Your credit score is a calculated formula based on information from your credit reports that predict your credit behaviour, for example, how likely you are to fulfil your commitment to repay your loan timeously.

Once you decide to buy a house or property your first step will be to approach a bank or a mortgage broker for a home loan. The lenders will want to make sure that you will be able to pay back your loan according to the terms.

That is where your credit score comes in, because your credit score plays the most important role in whether you will qualify for a home loan or not.

How credit scores are calculated

Your credit scores are calculated by using of a variety of factors related to your credit history from information summarised in your credit report. These factors will differ from person to person, but could include the following categories of which each contributes a specific percentage that make up your credit score:

• The age or history of your credit report

• How frequently and how much you have borrowed in the past

• Your repayment history – your ability to pay on time

• Whether you have been declared bankrupt before or if there are any court judgments in your name

• New credit – research has shown that people who don’t have a long credit history presents a greater risk

• Credit mix – such as retail accounts, credit cards, and loans

Do you have a dream home in mind or have you noticed one that is on the market and you are keen to know if you will qualify for a home loan? Then you can use a borrowing power calculator for a comprehensive estimate of not only your home loan potential, but also your borrowing capacity, and more.

Credit Scores and Home Loans

Minimum credit score requirements: Your credit score will be somewhere between 0–1000 or 0–1200, depending on the particular lender. If your credit score is lower than 500 it could present a challenge to get approval for a home loan. However, if your credit score is 650 to above 700 the chances are good that your home loan application will be approved.

A good credit score will notably impact on the interest rate that you are offered, due to your creditworthiness. In other words, with an excellent credit score you are very likely to be offered the best competitive interest rates at the time of your application.

Impact on eligibility and interest rates: There are various factors that determine home loan eligibility such as your income and employment, because a secure position with a high salary will make your application more favourable for approval.

You also have to be an Australian citizen or a permanent resident and at least 18 years old. Alternatively, you may not be a citizen or resident in Australia, but you are married to a citizen or permanent resident, or in a de facto relationship with them. If you are a temporary resident, you may also apply, but will need approval from the Foreign Investment Review Board (FIRB). 

Do you have other sources of income, for example, allowances, or you are self-employed (business), or receive interest on investments? You may also include these on your application.

Your age and the loan term are important factors to determine your eligibility for a home loan, and of course whether you have a deposit or not (a large deposit will cause you to pay less interest over the loan term).

Improving Your Credit Score

Tips for improving your credit score:

1. This is something that will take time, but it will be in your best interest to build and maintain a good credit history, and to monitor your credit score regularly.

2. Find those items that cause damage to your credit score and address them. Also check your credit report for inaccuracies, incorrect information or signs of fraud. Contact the credit reporting body to fix it.

3. Start paying off your debt and loans. You will need a lot of self-discipline for it, but a good way to do this would be to use the snowball method. List all your debts and identify the debt with the smallest balance (which will be paid up in the shortest time), or, the debt with the highest interest rate. Use any extra cash that you have available to settle this debt while continuing to pay the minimum balance on the rest. When you have paid up the first debt, take all the money that you used to pay up the first debt and roll it on to the next debt on your list. By the time you get to the third debt on your list, the snowball will gain momentum and you will pay off your debt in no time.

4. Ensure that you always pay your bills on time. If you are able to, pay more than the minimum amount, but never pay less. This will show lenders that you are a reliable and responsible borrower.

5. Keep your old credit card accounts open. This may improve your credit utilisation rate.

Common mistakes to avoid:

1. Limit your new credit applications.

2. Don’t miss a payment and pay your bills on time. Failing to do so could cause great damage to your credit score and your potential to get a home loan approval.

3. Making the minimum payment merely to stay within your budget will cause you to lose money on high interest charges.

Application Process

Applying with different credit scores:

Supposing that all your credit information is correct, you are allowed to submit different credit scores from different reputable credit reporting agencies. Because different agencies interact with different lenders and service providers, the information that they have about you will differ.

Seeing that your credit score with them is usually re-calculated monthly, they are able to update their data and re-calculate their credit score. Therefore, you should regularly check your different credit scores, as well as the information listed on your credit reports.

The more accurate these agencies’ information is about you, the better for you, because if you should apply for a home loan the lenders will obtain this information from them.

Required documents: Avoid the stress when you apply for a home loan by having all your required documentation organised and prepared in advance. The following are a list of documents that will be required during your home loan approval process:

Personal Identification: Primary identification such as passport, driver’s licence, a State or Territory-issued photo identification card such as Proof of Age Card.

Alternatively, you can present two forms of secondary identification, including: birth certificate, Medicare card, Australian Citizenship certificate, utility bills with name and current address, Tax assessment notice, or a debit/credit card with your name.

Proof of income: The documents you provide will vary, but it will help to determine your home loan eligibility.

Full-time or Part-time employment: This will include two of your latest payslips, your employment contract or letter of employment with all details such as your basic salary, allowances, and length of employment.

Alternatively, you can present your bank statements for the last three months to prove your income.

Self-employed: If you are self-employed, you will need –

1. One-year individual tax return (not older than 22½ months) and accompanying Australian Tax Office notice of assessment.

2. One-year business tax return, profit and loss statement and balance sheet (not older than 22 ½ months).

Other income sources: These may include rental income, dividends, superannuation, foreign income, pension, annuity or other government income sources.

For a rental income you will need to provide a letter from a real estate agent, as well as a current Residential Tenancy Agreement (excluding private lease agreement), bank statements confirming rental payments for the last three months, and tax return with rental income included. For the rest you will also have to provide proof of income for the last three months.

List of Assets: The current market value of any assets you own that has a tangible or precise measurable value, such as property, including land, motor vehicles, investments, savings, professional equipment (e.g. tools of trade), home contents (the insured amount).

List of Liabilities: You will need to provide three months’ statements of credit cards, loans, etc.

Everyday Living Expenses: This includes regular utility bills including gas, power, water, mobile phone and pay TV subscriptions, as well as Council rates, body corporate, any ongoing maintenance, as well as a transaction account and/or credit card statements.

This could help estimate your monthly expenditure on things like groceries, eating out, movies, gym membership, insurance premiums and so on. Other more regular expenses for school or tertiary costs, and child care or child support payments will also be required.

Ongoing rental expenses: If you are going to continue renting after you have bought a home you may need to provide three months’ bank statements showing rental payments made, together with a formal lease agreement. 

For help with applications based on credit scores, contact our expert mortgage brokers for a free consultation.

Alternatively, click on one of the links below to start your home loan or refinance application process.

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