How to Improve Your Credit Score

As a mortgage broker, I take applications everyday and often get asked the question about how the credit score affects the interest on a home loan. For those with some challenges on their credit report, I am also faced with the question of how they can improve their score to help them qualify or obtain better terms on their home loan. Your credit score has always been somewhat of a mystery. You check it periodically and it may fluctuate 50 points when you feel you have done nothing to provoke the change. What are some of the factors that feed your credit score? What sources should I trust for monitoring your score? What can you do to quickly improve your score? How does credit score influence terms on a home loan? These are some of the questions that I intend to discuss.

FICO vs VantageScore

While I encourage everyone to monitor their credit profile, all services are not created equal in terms of dependability when it comes to their score. Knowing which algorithm is being used to determine the score is the first step. For example, Credit Karma (among others) are using VantageScore to calculate the credit score. If you are using Credit Karma, I do not want to deter you from it. It is a good service, but you should know that the score it reports is not the same score that will be used when you apply for a new home loan.

Mortgages, in particular, use a FICO 2, 4, and 5 to determine creditworthiness. This method ensures that credit is examined from all three of the major bureaus (Transunion, Equifax, and Experian). We could get into more detail about these algorithms, but it is too in depth for this article. For now, just examine what scores you are being given. Whether it is a VantageScore or a more recent FICO variant. If you are not looking at your FICO 2, 4, and 5, your score will vary when you apply and your credit report is obtained.

What factors affect my credit score the most?

As you probably gather, paying your bills on time each month has the biggest influence on your credit score. As you can see from the chart, paying your bills on time actually accounts for 35% of your score. Because of it consuming the largest portion of your score and the time it takes to recover from a late payment, this is the hardest obstacle to overcome and ultimately raise your score.

Next you have the amounts owed which is worth 30% of your score. This is taken in comparison to the amount of credit that you have available. So for example, if you have 2 credit cards that have a limit of $10,000, your total credit line is $20,000. If you have a balance of $5,000 on each card, you will have 50% utilization of your credit. Again, because of the high proportion that this has on your credit score, you can pay down your balances and see major shifts to your score.

Length of credit history consumes 15% of your score. To determine length of credit history, all of the open accounts on your report are examined and then averaged together. So if you have 3 accounts that have an age of 6 years, 4 years, and 2 years respectively, your length of credit history would show as 4 years. If you add another account, your length of credit history score will drop initially to 3 years. For this reason, it is important to the homebuying process that you do not obtain new credit in the first few months before applying for a home loan and then until after closing on your home loan.

A variety of different type of credit is also important and accounts for 10% of your credit score. Different types of accounts may be in the form of credit cards, retail accounts, installment loans, and mortgages. It is good to have a variety. If you are new to credit, it might be advantageous to take out an installment loan to make a large purchase instead of charging it to a credit card.

Finally, your credit score looks at how many times you have applied for credit in the last 12 months. If you have many inquiries on your credit report, it is possible to see a decrease in your score. Since this only accounts for 10% of the score, the impact of inquiries may only be minimal. I often am asked if me running credit in conjunction with a home loan application will lower their score. The answer is yes it will, but as long as all of the other factors are maintained, the drop will be very minimal.

How to improve your credit score…

As mentioned briefly above, there are many ways to improve your score. Here are some pointers:

  1. The first and most obvious way is to make on-time payment each month to your creditors. Understandably, sometimes a bill is forgotten or you just did not have the money to pay it that month. Do not let one month, where you may have slipped, destroy your payment rhythm.
  2. Pay down your credit cards. Some sources believe that maintaining a balance of less than 30% is ideal.
  3. When you start thinking of applying for a home loan, do not apply for new credit until the process is completed. This will lower your average age of credit as well as add inquiries to your credit.
  4. If you have derogatory or collection accounts, look to pay them. Sometimes you can contact the creditor and arrange for them to remove the account from your credit completely once you have paid the arranged amount.

You may qualify for a home loan despite some bad on your credit report

All hope is not lost, and you may not need to improve your score at all to qualify for a home loan. There are many programs out there to assist homebuyers that have some negative marks or lower FICO scores. I would encourage anyone that is looking to purchase or refinance a home to speak with a Loan Originator to discuss whether they would qualify. Be honest. I can often qualify a borrower based on a phone call and have a pretty good idea of an approval before even running credit – as long as they are honest and upfront with the negative on their report. Remember it will all come out in the end. There are people buying houses every day that have negative marks, including bankruptcies, on their credit report. Give me a call or apply online if you are interested in purchasing or refinancing a home.