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Financing A Home: Improving Your Credit Score

Thursday, January 23, 2014

Today there are many homes for sale with low prices and low interest rates. Housing is more affordable now than it has been in many years. Considering the current market, why isn't everyone snapping up homes? The truth is, many first time home buyers are jumping into the market and getting in on this affordable housing opportunity. Real estate investors are also very active as they see this unique opportunity to build their wealth. The unfortunate reality for everyone right now is that even though homes are more affordable now than in many years, lenders are very picky about who gets a loan and who does not. And your credit score is one of the primary indicators of whether or not you will get approved for a loan and what your interest rate will be.

Just a few years ago a borrower with a credit score as low as 500 could buy a home. Today that score needs to be a minimum of 620 to 640. And to qualify for the best interest rates you better have a credit score in the 700's. No matter what your credit score is, you should know it. If it is not close to 750 you should resolve to get there and here are some easy tips to help improve your credit score.

Let's take a look at what information on our credit report determines your score, then we will give suggestions on how to improve in each of those areas

35% or your credit score is attributed to your payment history which not only includes actual payments to your creditors, but it includes things such as collections, judgments and tax liens. With this in mind you always want to make sure you make your car, credit card and loan payments on time. Many lenders also require verification of rental payment history, so you will want to make sure you pay your rent on time as well. By the way, a payment is considered on time if it is paid within 30 days of the due date. If you have collections, judgments or tax liens on your credit, you will have to provide proof that these were paid. If there are unpaid collections you can in many cases negotiate a settlement for less than what is owed. From a credit scoring standpoint this is almost as good as paying in full as long as it is reported as satisfied in full on the credit report.

In addition, you can make a payment arrangement for tax liens and after 12 months get those rated for your credit report which will help. Judgments are required to be paid in full at the close of a loan, and you will need to get it paid and the credit report updated in order to improve your credit score. In many cases with a history of late payments we have to say, time heals all wounds. In other words, it may just take a year or so of making your payments on time to get the credit score you need. If you have items on your credit report that are incorrect, then you can dispute those items to get them corrected with the credit bureau.

30% of your credit score is attributed to how much you owe on your credit card as a percentage of total credit limit. Let me give you an example: If you have one credit card with a $1,000 limit and you owe $750 on this card, your percentage of credit usage is 75% and your available credit is 25%. The lower the usage percentage the higher your credit score will be (all other factors being equal). There are 3 ways to improve this number. You can accomplish this by paying your credit card down as soon as possible. You can request an increase in the credit card limit. And you can also open up new cards. For the last two, you will need to exercise some caution however.

When you request an increase in your credit card, you should ask your credit card company if they can do this based on the merits of your payment history with them. If not they will create a credit inquiry which can lower your score just a little bit. In my opinion it would probably still be worth the credit inquiry deduction from your credit to get your credit limit increased. I believe that in most cases you would have a net gain in credit score, but there have been times when I've seen it drop at least in the short term. By the way, do not increase the balance on your credit card when your limit goes up or you will have just undone the improvement, but now you owe more money and still have a low credit score. Similarly, when you open up a new credit card, you end up having a couple of strikes against you which is the credit inquiry and the new credit account. More about both of these in a moment.

15% of your credit score is attributed to your length of credit history. So Let's have another example: Let's say you have 2 credit cards. You have had one of the credit cards for 5 years and the other card for 3 years. So on average your credit cards are 4 years old, and so your credit score will reflect this 4 year average length. Now if you open a new card, you reduce your average down to about 2.7 years from 4 years. So initially at least this can have the effect of lowering your average length of credit and reduce your credit score accordingly. That is one of the reasons that opening new credit is not a quick fix for bumping your credit score up. However lets take a look at it a year from now. In one year from opening the new credit card your average length would be at 3.6 so if this is part of a longer term strategy then it would probably be a good strategy to follow.

10% of your credit score is attributed to new credit, so once again you can see that opening a new credit account not only lowers your average length of credit, but it also counts against you on a stand alone basis as well. This is also why an inquiry affects your credit score as well. When there are inquiries, it is "assumed" by the system that you are acquiring new credit whether you are or not. For example, if you had your car at the dealership to be fixed and while you were waiting you were taking a look at a new car and ended up making an offer which the dealership knows you will be financing, they will make sure to run your credit (with your permission of course). So even though you end up not buying the new car, the credit inquiry is on your credit report and will slightly lower your credit score. By the way, all inquiries reported in a 30 day period from similar companies will be treated as one credit inquiry. So if you are going to be buying a car or shopping for a mortgage, try to get all of the inquiries put in within 30 days to lessen the effect of multiple inquiries.

The last 10% of your credit score is attributed to the types of credit used, or what we call credit mix. It is good to have both credit cards, car loans, mortgages and installment loans on your credit report. For most people it will take time to accomplish all of these, but beware that someone who always uses high interest rate, high risk lenders will have lower credit scores as well. I cannot mention them by name of course, but it is the lenders who would be considered a finance company, and makes high interest rate and unsecured loans for household goods that will decrease your credit score. Now it is not bad to have an account with this type of company. Many of them work with stores to offer no interest, no payments for 90 days or longer. As long as you are not using them with regularity. Once established you should be able to qualify for reasonable rate credit cards or even an installment loan at a bank or credit union with a competitive rate as well. So bear in mind as you build your credit and credit score that these factors all contribute to your overall score.

A couple of other thoughts for you. Many folks ask me what this or that will do to your credit score and unfortunately no one can tell you exactly as credit scoring is somewhat like Kentucky Fried Chickens secret recipe of 11 herbs and spices. It is a closely guarded, highly sophisticated set of algorithms that combines all the above stated factors and reduces them down to a simple 3 digit number that is supposed to represent your likelihood of paying back the loan or credit card you are applying for. You may want to connect with a lender who can assist with guiding you through the process of improving your credit score. There are also a large number of companies who will, for a price, work on your credit score for you. There are no guarantees with these services and in addition, they are usually fairly expensive and many of them are just plain rip offs, so you would need to approach this avenue with a great deal of caution.

Finally, as a consumer of credit services and possibly as someone who want so purchase a home, you should make it a priority to take control of your finances and your credit score and find out what your credit score is and work hard to bring it up or maintain it.

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