The housing market is highly competitive in many areas of the country right now thanks to a combination of low inventory and low interest rates. At publication, the average interest rate for a 30-year fixed-rate mortgage is 2.9%.
The average home price increased by 13.2% from last year, according to a Zillow report. In states like California and Utah, homes are staying on the market for an average of only 7 days.
If you want to buy a home and take advantage of lower interest rates, you’ll need to have a good credit score to compete against savvy buyers looking at the same homes. Now is the time to get your credit score in order.
A healthy credit score is one of the most important factors mortgage lenders look at when offering loans. An excellent credit score allows you to take advantage of current low interest rates. Lower rates could save you thousands of dollars in interest over the life of your loan.
What is a credit score?
Your credit score is a three-digit number, ranging between 300 and 850 (depending on the scoring company) that shows lenders their risk for lending to you. A higher credit score indicates that you’re more likely to pay your debts. The scores vary slightly between the major credit scoring companies, and your approval could be denied if your lender uses a different scoring metric than the one you monitor. Most lenders use one of your FICO scores or Vantage.
While free tools like Credit Karma and Credit Sesame can be helpful tools for monitoring your score, they don’t always accurately represent the number your lender sees.
How is your credit score determined?
Your credit score is important, but do you know how it’s calculated? While the exact equation can vary between credit bureaus, the factors that make up a credit score can generally be broken down like this:
- Payment history (35%)
- Amounts owed (30%)
- Length of credit history (15%)
- New credit (10%)
- Credit mix (10%)
By understanding the factors that influence your credit score, you can then take steps to improve it.
If there’s only one thing you change, make it this. Make all payments on time. Every month. While some lenders won’t report late payments until at least 2 weeks past the due date, make a habit of scheduling your payments before they’re due. If you have a hard time remembering to make payments, consider scheduling your bills for autopay to eliminate your risk of late payment.
If you have open accounts with delinquencies, take care of those as soon as possible. Late payments can stay on your credit report for up to 7 years, so get organized with your bill pay, if you want to increase your credit score.
The second largest factor in determining credit score is the amount you owe. This is sometimes referred to as your debt-to-income ratio (DTI). The DTI is your total monthly payments on debt compared to your income. For example, let’s assume you have the following debts:
- Student loan: $200 per month
- Car Payment: $300 per month
- Credit Card A: $50 per month
- Credit Card B: $100 per month
- Rent (or mortgage): $1400 per month
Total monthly payments on debt: If your income is $4000 per month, your DTI would be 51%. If you paid off both credit cards, your DTI would drop to 48%. Pay off that loan and your DTI drops to 40%.
Many lenders like to see DTIs below 36 percent.
You can adjust your DTI by increasing your income or decreasing your other debt payments. You can use an online mortgage calculator to determine your DTI.
Length of credit history
Sometimes called credit age, this credit measure looks the age of your oldest open credit account. An older credit age is better for your credit score. Avoid closing credit cards, even if you pay off the balance and don’t intend to use the card, to maintain your credit age.
How often are you applying for credit cards and personal loans? If you have too many new inquiries or new accounts, this could hurt your credit score. You can manage this by only applying when you’re confident of approval.
Lenders like to see a mix of revolving and secured debt. If all of your debt comes from credit cards, this could hurt your score a little.
Why is a good credit score important?
Your credit score directly affects the amount of money you’ll be able to borrow. This is important, especially if you’re planning to move to a bigger house or a better location. You’ll want to maximize your borrowing power as much as you can.
A credit score, of “very good” (740-799) or exceptional (800+), indicates to lenders that you can be trusted with more money, because you’ve demonstrated that you can pay back what you borrow.
A credit score in the healthy range will also give you access to low-interest rates. This is the golden ticket you’re really striving for! It’s up to specific lenders what score they use to offer low-interest rates but even a few extra points on your score can make a substantial difference to your monthly payments.
Additionally, your credit score can affect your utilities, the ability to buy a new car, or even renting a home.
5 Steps to Take to Improve Your Credit Score
Improving your credit score won’t happen overnight, it can take a month or two. Most lenders report payments to credit bureaus once per month, so updates to your score and report will reflect that.
While it can take time to improve your score, it’s well worth the effort. Higher credit scores mean lower interest rates, and a lower interest rate can save you a lot of money over the life of your loan.
Ready to improve your credit score? Here are 5 steps you can take to start improving your credit score right now.
1. Check for errors on credit report
Mistakes and inaccuracies on credit reports are more common than you might think. Consumer Reports conducted a study. More than a third (34%) of participants found at least one error on their report.
Common errors on credit reports include:
- Duplicate accounts
- Incorrect accounts
- Fraudulent accounts
- Incorrect payment statuses
- Outdated information
It’s important to check your credit report and your credit score at least once per year. Look for errors or signs of fraudulent activity on your accounts. You can request a free annual copy of your credit report from each of the three major credit bureaus — Equifax, Experian, and TransUnion — through AnnualCreditReport.com.
If you find an error or inaccuracy in your credit report, you can lodge a free formal dispute to get it corrected. Depending on which reports show the error, you can file with one or all the bureaus. Instructions for filing credit report disputes, and the information you will need to provide as evidence, can be found on the respective websites.
It takes around a month for dispute resolutions to be processed and a bit longer for your report to be updated. If you don’t see any changes after a month or two, call the customer service line for the credit reporting bureau.
2. Pay off debt owed and diversify your credit mix
The amount of credit you have and how much of it you’ve used (known as ‘credit utilization’) makes up 30% of your credit score. In addition to reducing your total debt to income ratio, you should avoid maxing out any single credit card. Ideally, you should use less than 50% of the total amount of credit available to you. Reducing your other forms of debt can significantly affect your credit score when applying for a mortgage loan.
One way to reduce your debt is to use any proceeds from the sale of your home to reduce credit card or loan balances.
Paying off debt is a positive move but having a mix of credit to your name can also help increase your score. Having a few different types of loans, and repaying them responsibly, suggests you may be less risky than those with only one type of credit. Since credit mix only makes up 10% of your credit score, this is less important than paying your bills on time and reducing your debt. In the short term leading up to your mortgage application, it’s better to show you can pay off one loan than open a bunch of new lines of credit, which can hurt your score.
3. Pay bills on time
If you think it’s alright to pay a bill late, think again. Your payment history accounts for 35% of your credit score, and a payment that’s over 30 days late can knock 100 points off your score. A drop in 100 can put your score into a lower range and reduce your borrowing options.
If an unpaid bill goes into debt collection that’s even worse as it can stay on your credit report for seven years. Set up automatic payments or a calendar reminder to pay bills on time.
Pro tip: You can get a bump to your credit score by using Experian’s credit score boost. The free program allows you to add your rent, utilities, and cellphone payments to your credit report. If you always pay these bills on time, it could benefit your credit score. Avoid using this tool if you’re not confident you can make the payments on time.
Certain mortgage brokers like REX Home Loans also offer options for rapid credit repair. It can pay to speak with a non-commissioned loan advisor ahead of applying for your mortgage.
4. Minimize credit card spending
In the months leading your mortgage application, concentrate on paying off as much of your credit card debt as possible. Aim to keep all your debt balances low as well.
You might consider paying off your credit card weekly, rather than on the due date since you can’t predict when a lender will pull your credit report to get a snapshot of your account balances.
5. Think before opening new credit (or halting it)
New credit makes up 10% of your credit score. Numerous credit inquiries in a short span of time are a red flag to lenders that you’re too reliant on credit, which can lower your score.
Hold off on taking out large personal loans or applying for new credit cards, if you plan to apply for a mortgage in the next few months. It should also be noted that once you’ve been preapproved for a mortgage loan, you shouldn’t avoid using your credit cards entirely. Changes in spending habits can alter your DTI and credit score, putting your loan at risk of final approval.
Remember, you’re looking to give yourself the best chance of success when applying for a new mortgage loan. Be sure to check your credit score monthly and follow our tips to boost it as much as possible before you apply.
If you’re ready to buy your next home, get in touch with REX Home Loans. We’re here to help you explore your lending options and find the best possible rate to get you into a home you’ll love.
Give us a call at 855-205-0599.