Your credit score is an important metric of your financial stability. It is especially vital for home buyers planning to finance a home purchase. A great credit score (above 760) enables you to get the best interest rates. Lower interest rates increase your buying power and keep your monthly costs as low as possible. This is especially important given the current circumstances with rising interest rates.
The tips below are applicable if you just entered adulthood and are starting to build credit, or if you’ve traveled this road for a while and you’re hoping to optimize your credit score. Regardless of your stage in life, it all starts with budgeting so you can stay on track with payments and reduce debt.
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Why is a credit score so important?
Creditors use your credit score as an indication of your financial responsibility and ability to make payments on time. Credit scores can range from 300 to 850. Most mortgage lenders require a minimum credit score of 640 with a few exceptions. A higher credit score also increases your ability to secure a rental property and receive lower interest rates on auto loans, mortgages and credit cards.
Your credit score is a fickle number and there are online podcast personalities that advise against having a credit score at all. This is personal choice. Research it researched in detail, so you know exactly how it could impact your personal and financial goals.
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What is a credit report?
Your credit report is a record of your credit history that includes information about the timeliness of your payments and how much debt you currently carry. Numbers are assigned to certain financial activities that add up to your credit score. This credit score fluctuates with your credit activity.
How is a credit score calculated?
- Payment history (35%): Payment history indicates if you pay your bills on time as agreed, or if you have ever missed a payment. When you miss a payment, it will remain on your credit report for seven years and cause a significant drop in your score during this time
- Total amount owned (30%): The total amount owed or utilization rate calculates the ratio of how much credit you have available versus how much you actually use. Your credit score takes a big dip if you tend to max out your credit cards or use most of the credit available to you. Aditionally, keep in mind that it’s not the specific dollar amount but the percentage of available credit you use. For example, if you have a $1000 credit limit and you spend $1000, your utilization rate is 100%. If your credit limit is $10,000 and you spend $1000, your utilization rate is only 10%.
- Average age of accounts (15%): Lenders assume that you are a less risky borrower if you’ve had credit accounts in good standing for a long period of time. Please note that this score is derived from the average age of your accounts, not your total history. The age of all of your credit accounts will be combined and an average will be calculated from there.
- Type of credit (10%): Lenders like to see applicants who have experience handling a mix of loans: mortgage, multiple credit cards, auto loans, etc.
- Hard inquiries (10%): Every time you apply for a new line of credit it is marked in your report and affects your credit score. Lenders see it as a red flag if you try to open several lines of new credit over a short period of time. That said, these inquiries should only have a minor, temporary impact on your credit score.
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Tips to increase your credit score quickly
1. Check your credit score for free with Credit Karma or Credit Sesame. Your credit card statement might display your credit score as well, but the websites listed above offer more than just the number. Keep in mind that your mortgage lender will probably have a different number. It is, unfortunately, usually lower than the consumer number you find on websites or credit card statements
2. Regularly review your credit reports. Request your free credit report at annualcreditreport.com. Don’t pay for your credit reports. You are entitled to a free annual report from each of the 3 major credit bureaus. Annualcreditreport.com is the easiest way to get all 3 in one place. Review your credit reports for opportunities for improvement and any mistakes.
- Limited credit history. Maybe you are new to this and have not had enough time to build up your credit. In this case, your score might be low even though you’ve paid everything on time simply because your credit isn’t old enough.
- Do you have late payments? Are those accurate? The later the payment, the worse it looks on your credit. Pay them off as soon as possible. Check out resources like Dave Ramsey and Suze Orman to figure out a plan to move out of debt.
- Do you have any amounts in collections? This usually happens if you are more than 180 days late on a payment. The lender gives up on you and sells your outstanding debt to a collection agency for pennies on the dollar. Then the collection agency will chase you down for full payment.
- If your debt was paid off, you can call the lender and ask for the credit bureau to remove the late payment. They are not obligated to do this, but it doesn’t hurt to try.
- Do you have any high balances or maxed out credit lines? This also includes the latest “Buy now, pay later” online offers that seem like a good deal but really aren’t.
- Check for incorrect marks or anything that could indicate identity theft.
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3. Ideally, pay off your credit cards every month. If that is not possible, always pay at least the minimum payment on time to keep your account in good standing until you can start paying off the debt.
4. If you are just starting to build credit history:
- Pay down your balances and reduce your credit utilization rate to under 10%.
- Request a credit limit increase from your credit card company for an existing card. Consider calling your existing credit card companies to request and increase in your credit card limit. The reason for this is that your utilization percentage gets reduced by this increase. Do not spend this credit card limit increase, as this would defeat the purpose. This is not recommended if a higher credit limit is too tempting for you to spend more.
- Try Experian Boost. It’s a completely free opt-in service that links all accounts, tracks on time phone and utility payments, and adds them as new positive tradelines to your Experian credit file. This can give you additional positive credit history and is highly recommended if you pay your bills on time and need a credit score boost.
Related Reading: How much home can I afford?
5. NEVER close old credit card accounts since this could reduce your average age of credit lines. Pay attention to any annual fees that some credit cards have and downgrade your accounts to a “free” card so you don’t get dinged for missing the annual fee payment.
6. Consider becoming an authorized user. You can piggyback on someone else’s good credit history if they add you as an authorized user to their credit card. This will add their credit history to yours and you’ll get the boost of their great history. BUT: credit bureaus are catching on to this and new history is sometimes not transferring to credit reporting companies. Keep in mind that any late payments and negative remarks transfer over to the credit bureaus in your name. If you are adding an authorized user to your account to help their credit history, make sure they have 3-5 years of credit experience, no late payments and everything in good standing.
Avoid paying for any credit repair services. You can accomplish these steps listed here on your own and could improve your credit score.
Disclaimer: This blogpost is not to be considered financial advise, these are just opinions. Any links provided that are outside this to other websites are offered as a matter of convenience and are not intended to imply I endorse, sponsor, promote, and/or are affiliated with the owners of or participants in those sites, unless stated otherwise.
Our team is always here answer your real estate questions: 719-219-9739 or email susanna@co-regroup.com.
