Introduction
Mortgage is one of the largest financial decisions most individuals have to make throughout their lives. When seeking financing for a house, your credit score plays an important role in determining the rate of interest that you qualify for. An improved credit score can lead to lower interest rates, making your mortgage cheaper and you saving money on interest payments down the line. Conversely, a poor credit score can lead to increased rates, which will cost you more per month and on the entire loan. If you’re going to be a homebuyer, it’s crucial to begin building your credit score early. The good news is that there are many steps you can take to improve your credit and better your chances at receiving a lower mortgage interest rate. In the following, we outline these strategies at length.
Making Sense of Credit Scores and Mortgage Rates
Before we jump into the strategies, it’s necessary to know how credit scores operate and why they’re important.
What is a Credit Score?
A credit score is a three-digit number between 300 and 850 that shows your creditworthiness. The lender will use this number to determine how likely it is to lend you money.
How Credit Scores Impact Mortgage Interest Rates
Lenders put borrowers into varying risk categories based on their credit score. The better your score, the less risk you appear to pose, and this generally translates into more favorable mortgage terms, such as:
- Lower Interest Rates – A high credit score makes you eligible for the most attractive available rates, lowering your overall cost of borrowing.
- Improved Loan Approval Prospects – A good credit score gives you a better prospect of approval for a mortgage.
- Smaller Down Payments – Excellent credit borrowers can receive lower down payments from certain loan programs.
- Increased Negotiating Leverage – Having a high credit score means you might have greater negotiating leverage for improved loan conditions.
Here is a general overview of how credit scores influence mortgage rates:
| Credit Score Range | Impact on Mortgage Rate |
|---|---|
| 800 – 850 | Excellent: Lowest interest rates |
| 740 – 799 | Very Good: Competitive rates |
| 670 – 739 | Good: Reasonable rates, but not the lowest |
| 580 – 669 | Fair: Higher interest rates |
| Below 580 | Poor: May struggle to get approval or face very high rates |
With this knowledge of how vital a good credit score is, let’s look at how to raise yours before taking out a mortgage.
1. Get and Read Your Credit Report
Step one in getting a better credit score is knowing where you are. Ask the three largest credit bureaus—Experian, Equifax, and TransUnion—for your credit report and examine it for errors. You can get a free version every year from AnnualCreditReport.com.
Key Things to Check in Your Credit Report
- Personal Information: Verify your name, address, and other information.
- Account Status: Check for any accounts that are listed as delinquent, charged off, or in collections.
- Credit Inquiries: Check who has accessed your credit and if there are any unauthorized inquiries.
- Errors or Fraudulent Activity: Dispute any inaccuracies you find with the credit bureau right away.
2. Pay Bills on Time to Build a Positive Payment History
Your payment history contributes 35% to your credit score, the most important factor. A single missed payment can drastically reduce your score.
How to Make Timely Payments
- Automate Payments: Most banks enable you to schedule payments so that they never become late.
- Use Calendar Reminders: Make reminders a few days in advance of due dates.
- Contact Creditors if You’re Struggling: Some lenders may offer hardship programs if you’re having trouble making payments.
A consistent track record of on-time payments will steadily improve your score over time.
3. Reduce Your Credit Utilization Ratio
Your credit utilization ratio measures how much of your available credit you’re using. It accounts for 30% of your credit score and has a significant impact.
Tips to Lower Your Utilization Ratio
- Keep Credit Card Balances Low: Aim to use less than 30% of your credit limit at any given time.
- Pay Off Current Debt: Pay down credit card and revolving account balances.
- Ask for Credit Limit Increase: If your income has risen, ask your lender to increase your credit limit. This can decrease your utilization without raising spending.
- Make Multiple Payments Monthly: Paying your credit card balance several times a month will keep your utilization low.
A lower credit utilization ratio tells lenders that you use credit wisely, which can increase your score.
4. Do Not Open Too Many New Accounts
Each time you apply for a new line of credit, the lender does a hard inquiry, which may lower your score temporarily. If you are looking for a mortgage, don’t apply for several credit cards or loans in one shopping session.
But if you must obtain new credit, apply sparingly and limit multiple requests over a short time.
5. Leave Old Credit Accounts Open
Your credit cards’ age plays a role in 15% of your credit score. Closing your old accounts reduces your age and hurts your score.
Best Practices
- Leave Long-Term Accounts Open: Even though you don’t use them frequently, they contribute to your credit history.
– Use Older Cards Every Now and Then: Small charges on older credit cards can keep them active and add positively to your score.
6. Consider a Credit-Builder Loan or Secured Credit Card
If you have a limited or poor credit history, a credit-builder loan or secured credit card will help you build good payment history.
How They Work
- Secured Credit Card: The secured deposit is refundable and the card functions just like a standard credit card.
- Credit-Builder Loan: A short loan that you pay back in installments, which will help your payment history.
Utilizing these in a responsible manner can really help raise your credit score.
7. Negotiate to Delete Negative Items from Your Report
If you have negative entries, like late payment or collection accounts, you might be able to get them deleted.
Steps to Take
- Call the Creditor: Inquire if they are prepared to delete the late payment entry for paying in full.
– Negotiate a “Pay-for-Delete” Agreement: Pay an agency to delete a collection record if you pay off the amount due.
8. Avoid Excessive Hard Inquiries
Every time you open up new credit, a hard inquiry is made. Too many hard inquiries can decrease your score.
What You Can Do
- Limit New Credit Applications: Apply for credit only when needed.
– Shop for a Mortgage Within a Short Timeframe: Several mortgage applications within 14–45 days are generally considered as one application.
9. Become an Authorized User
If there is a friend or family member with a properly managed credit card, inquire whether they would add you as an authorized user. This can help boost your credit score by applying their good payment record to your credit history.
10. Be Patient and Consistent
You have to be patient and disciplined for your credit score to improve. Keep doing the above steps religiously, and in time you will see improvements.
Extra Strategies to Give Your Credit Score an Extra Push
In addition to the essential steps described above, there are some extra strategies you can pursue to maximize credit score gain. These advanced tips can assist you in obtaining the best credit profile and the most desirable mortgage loan terms.
11. Spread Your Credit History Across Multiple Account Types
Your credit score gains from having more than one kind of credit account, including:
- Revolving Credit (e.g., credit cards, lines of credit)
- Installment Loans (e.g., car loans, student loans, personal loans, mortgages)
A balanced mix of various types of credit contributes 10% of your credit score. Don’t, however, open new accounts merely to diversify. Instead, use existing credit wisely and add another type of credit only if it’s financially wise.
12. Pay Off Outstanding Collections Accounts
If you have accounts in collections, these can badly hurt your credit score. Here’s how to deal with them:
- Negotiate a Pay-for-Delete Agreement: Certain collection agencies might delete the negative mark if you settle the debt.
- Request a Goodwill Deletion: If you already settled a collection, ask the creditor to delete the record as a goodwill gesture.
- Dispute Inaccurate Collection Accounts: If a collection account is inaccurate, dispute it with the credit bureaus so that it can be removed.
A collection account can stay on your report for seven years, but its effect on your score diminishes as time goes by—particularly if you take action to have it taken care of.
13. Use Credit Responsibly Even After Getting a Mortgage
Once you have a mortgage, keeping a high credit score is still essential. Future financial prospects—refinancing your mortgage or getting other loans—will be contingent on your creditworthiness.
Best Practices After Mortgage Approval
- Keep making all payments on time, including your mortgage.
- Refrain from accumulating too much new debt that raises your debt-to-income (DTI) ratio.
- Keep credit card balances low in order to keep your utilization ratio good.
- Check your credit report frequently to avoid fraud or identity theft.
Having good credit habits after you’ve bought your home keeps you financially strong and ready for whatever lending requirements the future may hold.
Mistakes to Avoid When Improving Your Credit Score
Even with the right intentions, there are some missteps that delay your progress. Watch out for these landmines:
1. Closing Old Credit Accounts
Closing old accounts shortens your overall available credit and your credit history, both of which can decrease your credit score. Do the opposite, leaving old accounts open and occasionally charging them to keep them active.
2. Maxing Out Credit Cards
Even when you pay the entire balance in full each month, maxing out your cards raises your utilization ratio and may hurt your score. Keep it under 30%, or better still, under 10%, for optimal performance.
3. Having Too Many New Credit Accounts in a Short Time
Every hard inquiry slightly reduces your credit score. When you apply for several credit cards or loans at once, it can make you appear to be a high-risk borrower.
4. Disregarding Credit Report Errors
Errors in your credit report can harm your score unnecessarily. Check your report frequently and challenge inaccuracies to avoid unwarranted harm to your credit reputation.
5. Making Only Minimum Payments
Making only the minimum payments on credit cards may result in accumulating high-interest debt and damaging your credit score. Always try to pay more than the minimum or, when feasible, pay the full amount every month.
How Long Does It Take to Improve Your Credit Score?
How long it takes to raise your credit score depends on where you’re starting and what you do. Here is a general estimate of the time required for different credit situations:
| Credit Situation | Estimated Time for Significant Improvement |
|---|---|
| Minor mistakes or one or two late payments | 3–6 months |
| High utilization | 1–3 months after bringing balances down |
| A few late payments or a single collection | 6 months to 2 years |
| Bankruptcy or serious derogatory marks | 7–10 years to fully recover |
While some repairs, like reducing credit card debt, can have an almost instantaneous impact, others—like recovering from late payments—take time.
