Are you considering applying for a mortgage at some point in the near future? If you are, it is probably a good time to review your credit information and perhaps take steps to improve your credit score.
While a credit score is not the only factor that lenders take into consideration when determining whether you qualify for a home loan, your credit score plays a big role in the amount of interest you’ll pay on a loan.
If you are concerned about your credit score, there are certainly steps you can take to improve it. But first, let’s look at how credit scores work.
What is a Credit Score?
To put it simply, a credit score is a number that reflects how trustworthy you are when it comes to paying off your debt. While scores can be calculated a few different ways depending on the service used, here are a few common elements factored into your credit score:
- Payment history - do you pay your bills on time?
- Number of open credit lines
- Debt you owe
- Utilization ratio - how close do you come to reaching your credit limit every month?
Your score is determined based on the information provided in your credit report. It is reflected as a three-digit number, generally between 300 and 850. A higher number is a higher credit score, meaning you are better at paying your debts than someone with a lower credit score.
Typically, a mortgage lender will use what’s known as a tri-merge credit report when reviewing your creditworthiness. This report provides the lender with detailed information and credit scores from the three major credit bureaus (Equifax, TransUnion, and Experian) combined into a single report.
When using a tri-merge credit report, lenders commonly use the middle of the three scores. When there is more than one borrower, lenders will use the lowest of all the middle scores for qualification purposes.
However, if you have a less than perfect credit score, you may want to consider improving your credit score so you can get the most competitive interest rates available.
How to Improve Your Credit Score
It doesn't take as long as you might think to improve a credit score. One thing it usually requires is increased financial responsibility, but there are a few others practices you may not even realize could positively affect your score.
Here are some tips that may help boost your score:
1. Request your credit report and review it for errors
Typically, you may request to a free credit report each year from each of the three major credit reporting agencies through AnnualCreditReport.com. However, due to the COVID-19 pandemic, people can now get a free copy of their credit report every week, through at least April 2021.
Once you’ve received it, either digitally or in the mail, review it and see if there is any inaccurate or missing information. If so, report it to the credit bureaus immediately so the issue can be addressed. You can also contact the creditor or lender directly to resolve the issue. When an effort is fixed on your credit report, your score can improve right away.
2. Make sure to pay all your bills on time
Making your payments on time is a significant contributing factor when determining your credit score. One way to ensure you pay your bills on time is to not spend more than you can afford to pay back. Beyond that, it’s about simply remembering to pay the bills. Online banking makes this incredibly easy. You can set up automatic payments or schedule text and email reminders to alert you when payments are due.
A late payment will remain on your credit report for years, but the impact on your score will dwindle over time.
3. Reduce debt you owe on your credit cards
A utilization ratio, expressed as a percentage, reflects the amount of money you spend per month as compared to your credit limit. Nearly maxing out your credit card(s) every month, will have a negative impact on your credit score, even if you pay your bills on time. Lenders want to see you spend responsibly. Ideally, your credit card balances should be below 30% of your credit limit.
4. Don’t close any credit cards
Despite what you may think, canceling a credit card may actually hurt your credit score because it reduces the amount of credit you have available. Plus, the closed account will remain on your credit report and could factor in when calculating your score.
5. Don’t apply for any new lines of credit
Opening too many lines of credit, especially in a short amount of time, can hurt your credit score. Lenders may view that as a red flag, making you appear less financially responsible. Taking out new debt or large loans could lower your credit score, just the opposite of what you want.
6. Establish a positive credit history
Your credit score reflects the frequency with which you pay off your debt on time. If you have not had a credit card for very long, you will not be able to demonstrate a history of responsible spending and on-time payments. It’s important to establish a pattern so lenders know you are creditworthy. Even if you are not planning to buy a home soon, it may be a good idea to start building credit now. You'll be grateful down the road when you may receive a lower interest rate on your mortgage.
Do you have more questions about the role credit plays in buying a home? Our experienced mortgage professionals can help you.