Most borrowers focus on the credit score when applying for a mortgage. They figure they need the highest score possible to get a good interest rate and/or loan approval. While it’s true that having a great credit score increases your chances of loan approval, don’t discount the importance of your credit history.
Your credit history tells the lender a story of your financial responsibility. Even if you have a great credit score today, what was your credit like over the last few years? This is what lenders want to know. They need to see the history or pattern of your habits. In general, lenders look back over the last two years of your credit history. However, in some cases, they may go back even further if they feel there is more to the story.
What is Your Credit History?
Each of your credit lines makes up your credit history. Every time you open a credit card or take out a loan, it becomes a line item on your credit report. Every payment you make (or don’t make) becomes a part of your credit history. Even if you close the account, the history remains on the credit report for future lenders to see.
While a majority of your credit report is the open accounts you have right now or had within the last few years, your closed accounts remain on your account for 7 to 10 years. Lenders can see all of this information and use it to make a lending decision on your loan.
Why Would Lenders Look at Your Credit History?
You may wonder why lenders would care about what you did with your credit five years ago when things are so different now. Here’s the reason – it paints a picture for the lender. It helps the lender see your patterns. For example, if you ran into a tough spot five years ago and paid your bills late, a lender may want to know what happened. What caused the issues and did you overcome them? The lender may ask questions about how you plan to prevent that situation from occurring again so that they know you aren’t a high risk of default.
Your credit history also gives lenders an insight into your spending habits. Are there certain times of year that you overspend (say Christmas)? They will take this into consideration when determining if they should approve you for a loan. If you overspend during a certain time of year consistently and the lender adds a mortgage to your plate, it could put you in a risky financial position. While it’s not an official lending decision, it can play a role.
Does the Length of Your Credit History Matter?
If you have a credit score, lenders can generally accept any length of credit history, but a longer history can be better. If a lender can look back over several years to see how you manage your finances, it puts them in a better position.
Here are two examples:
Joe has a short credit history. His credit report only started 18 months ago. Within that time, Joe suffered a loss of income and was unable to pay his bills. He has several 30-day late payments on his credit report. In the last eight months, Joe was able to pull his finances together and get back on track. He was able to increase his credit score significantly, which should make him a good candidate for a loan. As lenders look at his credit report though, they may be wary of his recent (bad) credit and wonder if it will happen again since it’s only been eight months since he has gotten back on track.
Jan has a long credit history of 10 years. She has had a few ups and downs, with periods where she had 30-day late payments. The last three years have been great for Jan, though. Her credit score is high and she has no negative credit reporting for at least 36 months. As lenders look at Jan’s credit report, they may be more likely to avoid the ‘bad’ credit because it was so long ago and because Jan has a long history of having financial success.
What if You Don’t Have a Credit History?
There’s one more problem you can encounter – a lack of a credit history. If you don’t have a credit score at all, it could be because you don’t have enough trade lines reporting to the credit bureaus. In this case, lenders may be able to accept alternative credit sources. This is still a credit history of sorts; it just doesn’t come from the credit bureaus.
Typically, lenders want a 12 to 24-month credit history when using alternative credit. While this isn’t nearly as long as they would look back on a credit report, it works in certain cases. Lenders that accept alternative credit typically charge higher interest rates and/or fees in order to offset the risk that the loan poses.
When using alternative credit, you must be able to prove to lenders that you paid at least three trade lines on time for the last 12 to 24 months. These trade lines could include utility payments, cell phone payments, insurance payments, rent, or tuition.
Your credit history always plays an important role when you apply for a mortgage. Try keeping your credit in good standing even if you know you won’t apply for any new credit anytime soon. Lenders can go as far back as 10 years if they want to, although most won’t unless there is a situation warranting them to do so.