When it comes to getting a good deal on a mortgage, your credit score may be even more important to you than you realize.
It’s one of the three most important metrics lenders use to decide whether or not to approve your mortgage application; the higher your score, the more confident they are that you will make your monthly payments on time. Most home buyers don’t know how much their credit scores impact the mortgage rates they will pay.
Let’s play with some numbers.* A $250,000, 30-year fixed mortgage will require monthly payment of principal and interest of $1,527, for a borrower with a 620 score. That’s a total of $299,821 of total interest paid over thirty years.
If you have a better credit score of 700, you are considered a less risky borrower. You can expect to pay $1,313 monthly for a total of $222,689. If you have an extremely favorable credit score of 780, you fall into the top-tier range of borrowers, and lenders will likely offer you a lower mortgage rate along with more loan choices. Your monthly payment will be $1,280 for a total of $210,681.
Here are some tips to help you get your credit under control and turn it into an asset if it is a liability today.
Start now. Credit scores don’t change overnight. If you plan to buy a home a year from now, you need to get to work immediately in order to get your credit in shape by the time you apply.
Do a reality check. Order your credit histories from the three primary credit bureaus: Experian, Equifax and Transunion. Review them for accuracy. You’ll see immediately how detrimental making a payment that is late by only a few days can be to your credit.
If you see errors that you can document, ask for them to he removed. Take note of any really serious marks against you like foreclosure, bankruptcy, tax liens and collections actions. If you have any of these, they will remain on your record for five to seven years and you will have to work extra hard to improve every other aspect of your credit to qualify. Sign up for a service that will notify you of changes in your credit.
Pay your bills on time. If you have missed payments, get current and stay current. Sign up for a “wallet” program through your bank or online service. Pay your bills through your bank so that there is no delay.
With today’s technology, there is no excuse for ever making a late payment to a regular monthly creditor. The longer you pay your bills on time after being late, the more your FICO Scores should increase. Older credit problems count for less, so poor credit performance won’t haunt you forever. The impact of past credit problems on your FICO Scores fades as time passes and as recent good payment patterns show up on your credit report
Reduce your use of credit. Most people use their credit too much. Create a budget and learn to live on a cash basis. Use your credit cards only for purchases you can pay off quickly or for emergencies. Keep balances low on credit cards and other “revolving credit”; high outstanding debt can affect a credit score.
Don’t close unused credit cards as a short-term strategy to raise your scores, but don’t open new credit cards just to increase your available credit. Reducing your balances is important, but taking the next step and closing cards won’t really improve your case; lenders like to see that you have credit available. A closed account remains on your credit report.
Especially, do not close your oldest credit card account. A long history of using and making monthly payments will improve your score. However, this is certainly not the time to open new credit cards. New accounts will lower your average account age, which will have a larger effect on your scores if you don’t have a lot of other credit information. Rapid account buildup can look risky if you are a new credit user.
Keep balances low on credit cards and other “revolving credit”. This is also not the time to make large purchases. Rather reduce your outstanding debt by increasing your monthly payments. If making minimum payments has been your practice, stop now and pay more.
Have credit cards – but manage them responsibly.
In general, having credit cards and installment loans (and paying timely payments) will rebuild your credit scores. Someone with no credit cards, for example, tends to be higher risk than someone who has managed credit cards responsibly.
Don’t relax until you have closed on your new home. Mortgage lenders often pull the credit history of a customer the day before they close. If there is a significant change in their FICO or a new purchase that raises their debt, they are within their rights to raise the interest rate or cancel the mortgage altogether. Don’t relax until they hand you the keys to your new house.
*These are for demonstration purposes only. Your numbers may differ.