Understand how your credit is scored, and tips to improve your rating
There’s no denying the importance of good credit when it comes to buying a home. A score below 640 could make it nearly impossible to buy a home, and improving your score by even a few dozen points could lead to a lower rate that can save you more than $100 per month on your mortgage bill. In the months preceding you planned home purchase, you should check your credit reports for accuracy, and work to improve your score to give you the best opportunity to buy a home at a great rate.
Check your credit report/scores
We recommend that you check your Equifax, Experian and TransUnion credit reports at least six months before beginning your application for a home loan. This can be done for free once per year through www.annualcreditreport.com (a web site that will help you access each of the credit reporting sites). You’ll have to pay to get your actual credit score, but you will receive an otherwise full report that will show your payment history, total available credit and how much you owe. Review the reports for inaccuracies, and work with the credit agencies to correct any problems before you begin the loan application process. These reports will give you a good idea on ways to improve your credit score. If you would like to see a free estimated range of your FICO scores, go to http://www.bankrate.com/calculators/credit-score-fico-calculator.aspx. Remember, requesting and checking your credit report will not affect your credit score, as long as your request comes directly from the credit reporting agencies.
How credit agencies rate your credit
According to myFICO.com, a division of Fair Isaac (the company that invented the FICO credit risk score that most lenders use), credit scores are broken down into five different categories:
-35 percent: Payment history
-30 percent: Amounts owed and amount of available credit
-15 percent: Length of credit history
-10 percent: New credit
-10 percent: Types of credit used
Knowing this, you can easily see that the most important things to manage to improve your credit score are making payments on time and managing your debt to available credit ratio. A little bit of self-discipline can go a long way in improving your credit score.
Tips to improve your credit
Pay on time: Since 35 percent of your FICO score is based on your payment history, there is no better way to improve your score than to make you payments on time. According to myFICO.com, even being a day or two late on a payment could mean a drop of up to 110 points on your credit score. Set up automatic payments or payment reminders if necessary, but always pay your credit bills on time, or early. If you have missed any payments, all is not lost. The credit score formula places more weight on recent credit history than the on the past, so get the account current and begin paying on time. Gradually, your score will improve.
Use credit wisely: Those who consistently max out their credit cards are considered riskier investments, and have higher credit ratings. Those who use credit sparingly and keep balance in check have higher scores. Try to keep your debt to credit ratio (amount you owe divided by total amount of credit) below 50 percent. Below 20 percent is even better. Consider paying down your debt if possible to lower this ratio, or ask your credit card company to offer more credit. Just don’t be tempted to utilize this higher credit without thinking about the risk.
Use your old credit cards: Use cards for small purchases and pay them off promptly to show an active credit history on the cards. Don’t close your old credit card accounts, as it will lower your amount of available credit, and those with no credit cards are considered a higher risk than those who have them and manage them responsibly.
Limit applications for new credit: A high number of credit inquiries can adversely affect your credit score. Rate shopping doesn’t necessarily affect your score, but be aware that every time you look for new car, get a new cell phone or begin paying for utilities (television, electricity, gas, etc.), your credit probably will be pulled. Don’t open new credit cards in order to increase your available credit, as this can backfire and lower your credit score.