There is no secret formula to achieving a perfect credit score in 30-days or less. A perfect score takes a couple of years with good spending habits, paying bills on time, and learning what the credit bureaus are looking for in a perfect borrower. One of those rules is keeping credit card balances close to 30% of your limit while continuing to periodically use the credit card. To the credit score bureaus, that demonstrates responsible borrowing.
With that said, there are some quick actions you can take to make your credit history look better in a few months than it does right now.
The first thing to do is obtain full copies of all three of your credit reports. Before you can take action, you need the details in the reports, not just your score. You're entitled to one free copy of your credit report every 12 months from each of the three national credit reporting bureaus. Order online from annualcreditreport.com, the only authorized website for free credit reports.
With your reports in hand and well-studied, your first step is finding ways to remove negative items. You’ll need to learn how to read the codes on the report. Once you do, you can dispute negative items. Outline specifically what you believe is inaccurate when you write dispute letters. The trick is knowing that you don’t have to prove the negative event did not happen. Instead, the credit card company must prove that it did happen. If they can’t prove it in a short amount of time (often they cannot prove it), the credit bureaus must remove it from your report and your score should go up. You want to dispute these individually with each of the three credit bureaus because having the negative event removed by one bureau won’t automatically remove it from the other two.
Next, rebuild or improve your credit using a secured credit card. A secured credit card is backed by a cash deposit you make when you open the account. The deposit is usually equal to your credit limit. So if you deposit $200, you'll have a $200 limit. It seems counter-intuitive but opening a new account and using it responsibly will improve your credit score. It takes a little time, so you want to do this early in the credit repair process.
Ideally, if you have severely damaged credit, you want to start repairing it at least a year before you apply for a mortgage. But it’s never too late or too soon to begin improving your credit score. Here are other hacks to get started with right away.
1. Know the difference between installment loans and revolving credit. How you pay towards each makes a difference in your score. Installment loans are things like cars and appliances that when you paid them off the loan is closed. Student loans fall in this category but have different rules. Revolving credit is your credit cards. As you make payments on these, it frees up more credit for you to borrow against in the future. Revolving accounts don’t close just because you paid off one purchase. If you can pay off installment loans quickly while staying current with revolving accounts, it helps your credit score by improving your debt-income ratio. It also creates accounts closed in good standing. It can be more effective than making big payments on high-interest accounts just to lower your monthly payments.
2. Close those secured credit cards as soon as you no longer need them. You’re using a secured credit card as a stepping-stone to be approved for a major credit card. Once you are approved for a major credit card with a reasonable interest rate, you want to close the secure card. This is one of the few times that you want to close a credit card in good standing. Where you want to get is having three major credit cards in good standing and paying attention to the rule about keeping the balances on all three close to 30% of your limit. This is how good credit is built quickly.
3. Be very careful and mindful when applying for new credit. Think about how you will use those three new major credit cards. The mortgage application will be looking especially closely at your debt-to-income ratio. According to the FHA, "The FHA allows you to use 31% of your income towards housing costs and 43% towards housing expenses (utilities, groceries, etc.) and other long-term debt." Those numbers can vary based on your current credit score. You must make those major credit card amounts fit into the FHA (or other lenders) formula. The math is fairly simple. You calculate your DTI ratio by dividing your total monthly debts by your gross (pre-tax) monthly income. For example, if your recurring monthly debts total $2,000, and your gross monthly income is $6,000, you have a DTI ratio of 33% (2,000 ÷ 6,000 = 0.33, or 33%).
At its most basic, the mortgage loan application is looking for an acceptable credit score and an acceptable debt-to-income ratio. Neither is a specific number that you must hit perfectly. But you do need to fit in the acceptable ranges for both. And they work in tandem to determine if your mortgage application will be approved. The lower your credit score is, the higher the interest rate will be on your mortgage. A higher interest rate means your housing costs will be higher in the debt-to-income ratio. It all must fit within the formula based on when your new mortgage payment is included in the calculation.
What quick hacks can you offer for improving a credit score and debt-t-income ratio? Please leave your comments.
Also, our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions, inquiries, or article ideas to [email protected].