By Ryan Dibble, Flyhomes Mortgage
“How do I improve my credit score?” We often hear this question from our mortgage clients, as a higher credit score can help secure better mortgage rates and higher lender credits.
First, it’s important to understand how credit scores work: it’s less about your actual likelihood to repay a debt and more about how your credit history fits into actuarial data about how people with similar histories have repaid their loans.
Creditors use this data to estimate your probability of defaulting on a loan. Then, they adjust the eligibility or pricing of the credit you’re applying for accordingly.
Here are 8 actions we’ve used at Flyhomes Mortgage to help our clients improve their scores to get them into their new homes at the best prices possible.
1. Correct errors on your report. Mistakes are surprisingly common and seemingly can strike anyone at random.
One of our clients understood his credit score to be about 800, an excellent score that qualifies him for the best mortgage pricing. He completed his application … and his credit score came in below 700, severely limiting his options and dramatically increasing his interest rate (costs).
We found a big bank where he held an unused credit card for more than 10 years had marked him delinquent 18 months prior. It was a mistake by the big bank, and they fixed it when he asked. Five days later, his score was back to 796!
2. Reduce your debts. Credit utilization ratio—your outstanding debts relative to your total available credit—is a component of your score. If you have only one credit card with a $10,000 limit and a current balance of $1,000, your credit utilization is 10%. By paying down your debts, you can reduce your credit utilization.
We find this to be the most common way to improve credit scores. The most dramatic improvement we’ve seen was a client going from 678 to 721 with this method. They ended up saving ~$250 per month and $4,000 in closing costs by paying down their credit cards by ~$2,000.
3. Actually use your available credit. This one seems a little counterintuitive, but using your credit accounts and paying them off responsibly actually helps your score more than not using your accounts at all.
We recently worked with a client who exclusively used their debit card for expenses and not their credit card. This made them appear to be someone who doesn’t use credit or have a track record of making payments, which pushed their credit score lower. We advised them to charge $5 on one credit card and it immediately increased their credit score by ~15 points.
4. Diversify credit products. Credit scoring models take into account the type and quantity of credit accounts you have. If you’ve proven yourself to be eligible for credit from a diverse group of lenders (credit card, auto, student, mortgage, etc) and have successfully handled a variety of products, the model sees you as a good bet for a new loan.
5. Demonstrate responsible credit usage. Make your payments and make them on time, demonstrating your discipline consistently over time. Use a credit card for daily purchases and pay the balance in full when the bill arrives.
6. Increase limits on credit cards. In step 2, we talked about changing your credit utilization ratio by making the numerator smaller. You can also improve it by making the denominator larger. If you have a great payment record, use your credit card often, or have an increase in your household income, it’s worth calling your credit card company to ask for a limit increase.
7. Don’t cancel credit cards, especially your oldest line of credit! Canceling cards reduces your borrowing capacity and increases your credit utilization. Credit reporting agencies also value the length of your credit history, so closing older accounts may hurt your score. That said, if you have a card with a high annual fee, then the trade off of saving the money by canceling the card vs. the potential hit to your credit score might be worth it.
If you have multiple credit cards with the same bank and need to cancel one, you may ask your bank to transfer the credit limit over to one of your other accounts to limit the impact to your credit utilization ratio.
8. Give it time. Establishing your track record of being a good borrower can take some time, so be patient and stick with it!
Something else to keep in mind is that you don’t get a lot of benefit from pushing your score above 760. Most loan products provide benefits to people with scores above 740 or 760, but rarely do you see an additional benefit for higher scores.
Credit scores can be confusing, but if we understand a bit more about how they work, we can shape our profile to better reflect our actual creditworthiness through the lens of the credit scoring models.
Learning about credit scores? Check out “Will This Hurt My Credit Score?” 5 Credit Myths, Debunked and How to Build Your Credit History.
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