Improving your credit score can be a complex subject based on your individual situation (but not always). Fortunately, there are many resources available to help you. Making a few relatively small improvements will make a huge difference in both how much house you can afford and how much you’ll pay in interest payments. It makes a significant difference in both your monthly payment and the amount of interest you pay for 30 years.
Not only do people who are looking for a first home turn to FHA loans, but people with challenging credit scores also find success with FHA loans (even for your second, third or follow on home purchases). In 2019, the lowest score the FHA allows is 500. That’s a really low score and you’ll need to talk to a few mortgage brokers to find an underwriter willing to work with you but it is possible. With a score between 500 and 579, you’re going to have to come up with at least a 10% down payment. You’ll also have to meet other requirements that include having enough income to make the monthly mortgage payments. But that doesn’t mean it can’t be done.
Most lenders (FHA underwriters) require a score of at least 580. That can get you into your own home with a 3.5% down payment. If you’re looking at conventional loans (not FHA), these have different requirements and down payment levels. For most conventional loans, you’ll need a minimum credit score from 600 to 630 and up.
The hurdles to buying your home truly aren’t that high. Even if you’re credit challenged, it often doesn’t take much to turn it around in a hurry.
You can begin with the National Foundation for Credit Counseling® (NFCC®) or Consumer Credit Counseling Services (CCCS). A reputable counseling agency should send you free information about itself and the services it provides without requiring you to provide any details about your situation. Trustworthy services offer 45-90 minute counseling sessions free of charge and with no obligations. If a firm doesn't offer these, consider it a red flag and go elsewhere for help.
Once your credit score puts you in the driver seat to buy your home, you want to think about a better interest rate. Interest rates change daily but stay within relatively narrow ranges for weeks at a time. Today, interest rates definitely favor the buyer even if they are a touch higher than a couple of years ago.
According to Experian (a major credit score bureau), 21% of consumers have credit scores in the “good range” (670-739). With a credit score of 670, you’ll probably be offered an interest rate close to 5.5%. By improving your score to 800, your interest rate drops to 4.2%. Remember that interest rates change daily. The exact rate will be different but the relative savings remain the same.
That higher interest rate (5.5%) on a $250,000 home with 3.5% down payment will have a mortgage payment of $1,370. The same loan with a 4.2% interest rate will be $1,180 per month. That’s a savings of $190 per month (all in extra interest). Or $2,280 per year. Over a 30-year loan, the saving comes to $68,400. Clearly, you’re rewarded for having a better credit score.
The credit score model (FICO) has five major components. Each has a different weight, meaning that improving the component with the highest weight improves your credit score the fastest and the most. The components and weights are:
The “payment history” counts the most. Late payments, defaults, and bankruptcies have the biggest effect on the score. But that’s history and you cannot change it much. What you can do is obtain a copy of your credit report to review it for accuracy. You can dispute anything you don’t think is accurate. The original lender has to document the accuracy. If you dispute it and the lender can’t document it (they often can’t), the bad rating must be removed from your credit history. This improves your score.
Something you should know is that the bad stuff counts less and less as time goes by. The weighting of old information counts less than new information. Starting now, it does help keeping payments current. And almost everything falls off the report in seven years (some limited bankruptcy info remains 10 years). So make your payments on time. One late payment today can ding your score as much as 60 points.
The “amount owed” component fools a lot of people. Many people think that having a high balance owed and making payments on time is the best way to improve their score. A high balance does damage. The FICO model wants to see consumers borrowing a small amount of the available credit limit AND keeping payments current. That small amount is close to 30% of the available balance. Instead of one high balance, your score will benefit from two lower balances – and on time payments. This is also better than paying a little extra on a bunch of accounts with small balances owed. Owing a 30% balance of the maximum available credit is the sweet spot.
Also, pay close attention to the “length of credit history.” The longer your history of on-time payments to a particular account the better for your score. Even if the balance was paid off years ago but you could still borrow against it today (like a line of credit or old store account). Don’t close these accounts. Leave these open. This shows a good history of repaying loans.
You want to be very careful about opening “new accounts” shortly before applying for a mortgage (don’t do it for at least six months prior). Definitely don’t do it during the mortgage application period or before the loan closes. Too many people make the mistake of buying new furniture for their new house but it’s more important keeping a high credit score. Opening new accounts sends up red flags that you might be living on credit to pay your monthly expenses.
Doing these few things can be the most effective way of quickly raising your credit score to make you a happy homeowner in a few short months!
What tips can you add for improving credit scores? Please leave your comment.
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].