Your credit score is just three little digits, but they carry such enormous weight for a homebuyer. In fact, you might say that no single factor will affect the type of mortgage you can get more than your credit score. Your credit score is what lenders use to determine how likely it is that they'll be repaid on time if they fund your mortgage. The higher your score, the better your loan options. Although challenging, it is entirely possible to raise that score if you take a few focused actions.
The Importance of a Credit Report
If you're considering buying a home in the near future, you'll want to check your credit. Good credit is central to getting a home loan at an attractive rate, but what exactly does "good credit" mean? Basically, good credit means that you are financially responsible, pay your bills on time, and keep your checking account in the black. A good credit history makes you a safe credit risk for lenders.
Your credit history is reflected in your credit report. Credit reports are prepared by credit bureaus, most notably the big three: Experian, Equifax, and TransUnion. Each report is a history of your credit: a detailed financial history including the loans you have received and the credit cards you hold and use. The report will show the current balance on each account, payment history, credit limit, and whether the account was closed or remains open. Any late payments and collection actions are also listed on credit reports, which are kept by credit bureaus.
No Two Credit Reports Are Identical
Each of the three big credit bureaus will compile and prepare its own report, and they will not be identical. You are entitled to get a free copy of your credit report from each of the three big credit bureaus every year.
Three-Digit Credit Scores
Credit scores are provided by these bureaus using a form of credit scoring designed by the analytics software company Fair Isaac Corporation (FICO). Credit-scoring models factor in a number of financials, like the number of years you've had credit, how much of the credit you are currently using and whether you've paid on time as well as all credit applications and negative actions, like bankruptcy or collections. This three-digit credit score can range from a low of 300 to a high of 850.
Your credit score determines the kind of mortgage loan you might be able to get. Anyone with a low credit score — a score below 640 — may be offered subprime mortgages at a higher rate than a conventional mortgage because of the lender's higher risk. The repayment term might also be shorter, and some subprime borrowers may require a co-signer. A score of 700 or higher is a good credit score, and borrowers in this range will likely get a lower interest rate. The best scores are those over 800.
If you're hoping to become a homebuyer, you should take appropriate steps to improve your credit before applying for a loan. Most steps raise your credit score over time, so be patient and keep paying your debts on time. A few steps will up your score a bit relatively quickly (ideal for those who are eager to be first-time homeowners in the next year).
Traditional ways of improving your credit work over time rather than immediately, so count on at least three to six months to see noticeable change. That doesn't mean this isn't worth doing; it just means that the time to start is now.
How to Improve Your Credit Score
1. Timely Payments
Pay your monthly bills on time every month — not just credit card bills and auto loans but everything you owe, from rent to utilities. Use automatic payments when you can to stay timely with your payments. Late payments stay on your credit report as negatives for seven years.
2. Lower Credit Card Usage
Keep your credit card debt as low as possible over time. One part of the credit score calculation is credit utilization ratio, which is calculated by dividing total credit card balances to total credit limit. Your credit score will go up if you keep the utilization rate to less than 30 percent, meaning if your total credit card limit is $10,000, you keep monthly charges under $3,300. A credit utilization rate of 10 percent is best.
3. Don't Cancel Cards
Keep credit cards open even if you don't use them. Closing them may reduce your credit utilization ratio. Let's say you have three credit cards, each with a $5,000 limit. You charge about $3,000 a month, so your credit utilization rate is 3/15, or 20 percent. If you cancel one card, your total credit is now $10,000, making your credit utilization ratio 3/10, or 33.33 percent. That's above 30 percent, which will impact your credit score.
4. Be Careful with New Credit
Don't open new cards that you don't need. Every time you apply, there is a hard inquiry into your credit history, and this will ding your credit score regardless of your credit history. Hard inquiries stay on your credit report for two years.
5. Increase Credit Limits
Ask the bank to increase your credit card limit every six months or so. Many times, you can make the request online. With higher credit limits, you lower your utilization ratio. Don't ask for too much of an increase or it may cause the bank to check your credit, which will be a hard inquiry.
6. Pay Twice Monthly
Make two payments on credit cards per month. Most creditors only report balances to credit bureaus once a month. Paying on your balances twice a month keeps your running balance down for credit utilization.
7. Pay Off Debts
Bring overdue accounts current and pay off debt as quick as you can. The very best thing you can do to increase your credit score is to reduce the amount you owe.
8. Check Credit Reports
You have the right to get a free copy of your credit report from each of the big three credit reporting bureaus every year. Be sure you do so and review each one carefully to make sure all of the information is correct. Errors can pull down your credit score, and you have the right to dispute the information and get it corrected quickly.
9. Experian Boost
Sign up for Experian Boost, an optional program where the bureau takes into account your timely payments for utilities, streaming, and cell phone payments. You have to register at experian.com/boost and give Experian authority to connect to your bank accounts and verify payment history. You'll see an updated FICO score in short order. The average consumer who signs up for Experian Boost sees a credit score increase of 13 points.
10. Piggyback on Credit
If you have a family member with good credit, ask to become an authorized user on one of their credit cards. This will add a long account history of on-time payments to your credit report and will also lower your credit utilization ratio.
11. Add Rent Payments
What about all those timely rent payments? Why don't they count toward credit? They can count if you sign up for a service like RentTrack, Clearnow, or PayYourRent. These programs accept your payment, send it to the landlord and report timely payment information to the credit bureaus. Most of these services charge you a fee and will report the rent payments to all three major credit bureaus.