Credit scores heavily influence the process for the mortgage application. A higher credit score can help you lock in lower interest rates and provide lower monthly mortgage payments, which can potentially save you tens of thousands of dollars over the life of a 30-year fixed rate mortgage. A good credit score represents your dependability as a borrower. They are utilized by mortgage lenders to calculate the riskiness of lending to a borrower. While low credit scores can jeopardize your qualification for a loan or lead to higher interest rates, high credit scores equate to lower risks for defaults on loans and lower interest rates. As a result, the borrower can get more house (higher purchase price), or a lower monthly payment on a lower priced home. Because of credit scores’ influence on the interest rates set for borrowers, it’s valuable to look into improving it as much as possible before your mortgage application. You don’t want a low credit score to jeopardize your ability to take advantage of the current low interest rates in 2020. It's also important to know that the credit system isn’t perfect and may not reflect perfectly your willingness or ability to repay a debt.
To understand how to improve your credit score, it is important to first understand how they are calculated. Although there are many different types of credit scores and formulas used to calculate them, mortgage lenders typically look at FICO (Fair Isaac Corporation) scores when assessing applicants (although other scoring systems such as Vantage and other social network based ones are popping up). FICO scores utilize payment history, utilization (balance-to-limit ratio), length of credit history, recent activity, and credit mix to calculate your scores. There are three different types of FICO scores from each major credit bureau’s data utilized widely by lenders: Experian’s FICO Score 2, Equifax’s FICO Score 5, and TransUnion’s FICO Score 4. Because home loans offered by the mortgage companies Freddie Mac and Fannie Mae require these three scores, all of them tend to heavily influence the mortgage market. Although the formulas used to calculate credit scores may vary, the ways to improve them tend to raise scores no matter the specific formula. Let’s look into 9 different ways to improve your credit score.
1. Decrease Your Utilization Rate
As utilization is the second most important set of information in determining your FICO scores, making up about 30 percent of your FICO score, you want to be careful about your utilization rate. Utilization is your credit card’s balance-to-limit ratio. For FICO scores, a utilization rate of less than 10 percent tends to be ideal for credit scores, but for VantageScores, FICO’s close competitor, a utilization rate of less than 30% is acceptable. However, less than 10 percent utilization works for both dominating models, and in any case you do not want to exceed above 30 percent of a balance higher than the credit limit at any time.
2. Pay Outstanding Balances and Prioritize Debt
For best credit score impact, you want to pay off your full balance every month, if possible. For credit cards, keeping your balances as low as possible is key to a good credit score and goes hand in hand with a good credit utilization ratio. Prioritize paying off credit card debt, especially if it has high interest. When you decrease these balances, lenders are able to see that you are dependable with handling your credit.
3. Extend Your Credit History
Payment history is the most dominant criteria in the calculation of your FICO credit score, making up about 35% of it. 15% is based on criteria such as the average age of your credit accounts and the oldest age overall out of your accounts. For new users of credit, you can join trusted family members or friends as authorized users on their existing credit card accounts. The accounts’ payment history will be added to your credit report and can extend your credit history in your favor. You will want to be careful about who you are choosing to work with, and to make sure they are a reliable person who you will be comfortable sharing joint responsibility on this line of credit. Furthermore, you don’t want to partner with strangers on their credit cards, as partnering with strangers may lead to illegal actions on the stranger's end, and could be flagged for fraud by credit car companies.
4. Self-Report Additional Payments to Your Profile
If you have relatively little on your credit history, you can utilize payments for essentials that you already pay for, like rent, to build on your credit reports. If you tend to pay rent on time responsibly, that can be represented and reported in your credit profile by all three credit bureaus. This implies that you will be able to build a favorable history without the factor of debt. Utilize services like RentTrack and ClearNow to add rent payments onto your credit reports. Additionally, services like Experian Boost and UltraFICO also allow you to add utility payments to improve limited credit history.
5. Don’t Close Old Credit Cards
In many cases, keeping credit card accounts open, even if you don’t actively use them, can help with your credit history. Closing accounts can detrimentally affect the average age and highest age category of your credit score calculation. Furthermore, it can hurt your credit utilization rate. Keeping your old credit card open can sustain your total credit limit and keep it high, which is generally beneficial for credit scores. Things to consider, though, are annual fees for keeping the account open, or whether you can downgrade to no-fee versions.
6. Set Up Automatic Payments
Building off the previous steps, in order to protect the payment history determinant category of your credit score, you want to pay your bills on time consistently. Insulate yourself from the detrimental effects of late payments on your credit score by setting up automatic payments. Missing a payment once, or multiple times, can have dire consequences on your credit score. On-time payments reported to credit bureaus will improve your credit score.
7. Be Careful About Applying for New Credit Lines
Approach applying for new lines of credit carefully due to the fact that an application for them qualifies as hard inquiries (which generally lower your credit score) This is in contrast to soft inquiries, like checking your credit score, which will not hurt your credit. Hard inquiries emerging on your credit reports can lead to decreases in your credit score that can last twelve to twenty-four. To avoid this, be conscientious about applying to new credit lines by researching beforehand whether you will qualify for them.
8. Keep Multiple Applications Within a Short Time Frame
Additionally, keep applications within a short time span to prevent multiple hard inquiries over a long time frame. This does not mean that you cannot apply to multiple loans or lines of credits at once, because credit scorers typically regard these hard inquiries as just one. Many borrowers will apply to multiple lines at once to compare them. It does, however, mean that you should keep them within a relatively short time frame and to be aware about exceeding it or starting a new time frame too often.
9. Monitor Your Credit Reports to Dispute Inaccuracies
In today’s digital age, the ease of being able to check and monitor your credit reports frequently is invaluable. Make sure to regularly monitor reports from all three dominant credit bureaus mentioned above: Experian, Equifax, and TransUnion. Utilize convenient online tools at your fingertips, such as Credit Karma. You want to verify that what’s being reported and updated are all accurate, and if there are any inaccuracies, immediately dispute them. These inaccuracies can drag your credit score down dramatically.
With a little planning and research, you will be able to increase the odds of getting the best mortgage rate possible. Monitor your credit score, pay down balances, limit revolving debt, delay that car purchase or credit card application until you have the keys for your new home in your hand. Good luck!