Purchasing a home can be the most rewarding financial transaction of your life. However, one aspect of the home buying process that’s often overlooked is the impact your credit score has on the interest rate you’ll pay on your mortgage loan. A lower credit score will require you to pay thousands of extra dollars over the course of the loan; and a good credit score will save you thousands.
How to improve your credit score
There are three major credit reporting agencies, Experian, Equifax and TransUnion and each agency has its own line of credit scores and each score has its own proprietary formula. Most of the credit scores are based on the following factors:
Late payments will lower your score. The more recent the late payment and the more it is late, the more of a negative impact on your score. There is nothing better at improving a credit score than making on?time payments consistently month after month. One way to ensure this happens is to set up automatic withdrawals on your accounts to assure payment is made automatically on or before the due date.
Owing too much will lower your score, especially if you’re approaching your total credit limit. Try to reduce this percentage as much as possible by paying down high balances.
Length of credit history
In general, a longer credit history is better. As time goes on, negative items from years past will have time to improve or will be weighted less and good payment patterns month after month will help increase your credit score. In addition, most negative items will fall off the credit reports when they are more than 7 years from the date of first delinquency.
Matters of public record such as bankruptcies, judgments and collection items will significantly lower your credit score. There are no “good” public records recorded on credit reports so these items are always negative and have more impact than any other factor. Judgments and collection accounts should be paid in full and satisfied if possible. Over time they will have less impact, but only time can help in this case.
Whenever someone else gets your credit report ?? a lender, landlord, or insurer, for example ?? an inquiry is recorded on your credit report. A large number of recent inquiries may lower your score. The impact on the credit score is typically 5?10 points, but this depends on how many inquiries are made within a given time frame. Avoid offers at retailers, for example 20% off or a free umbrella for signing up for a new store credit card.
New accounts opened
Opening multiple new accounts in a short period of time may lower your score. In addition to the inquiry that is done to determine if you are eligible for new credit, a new account can also have a negative impact on a credit score.
Make payments prior to statement date
One common misconception is that if you pay your account in full every month you are not “carrying a balance.” This may be true from the standpoint of interest accruing on the account. By paying the account off each month it typically avoids interest from accruing by the bank or credit card company. It is also true that after the payment is made that the account is then a zero balance. However, the issuer of the card issues a credit card statement on a given day, the “statement date.” Then payment is required to be made by the due date. See example below:
January Charges: $4,000
Limit on Credit Card: $10,000
Statement Date: 2/1/2012
Due Date: 2/9/2012
If you pay this account in full after the statement date and before the due date then the new balance on credit card is $0. However, the balance reported to the credit reporting agencies is $4,000 and therefore a credit utilization rate of 40% on this credit card. If you pay $4,000 on 1/31/2012 (just days earlier), then the statement will record a zero balance with no money due. In this case the balance will report to the credit reporting agencies as a zero balance and the credit utilization rate is now 0%. Another option would be to make a mid?month payment which would reduce the balance at the time of the statement closing. If you spend $4,000 a month on credit cards every month and pay it off immediately you would have a perpetual 40% utilization rate, even though you immediately pay the account to zero every month. By making the same payment a week earlier or making a partial payment in between statement cycles you can reduce the utilization rate and help to increase your credit score.