September 28, 2020
7 MINUTE READ
You are finally ready to purchase a home – congrats! You know the down payment is important. Did you also know that your credit score is just as critical, and perhaps even more so? If you have an average or poor credit score you’ll probably pay more – or you might not qualify at all.
Boost your credit score to save thousands of dollars in interest charges over the life of your loan with a lower mortgage APR. These five credit hacks can help you improve your score before you shop for your home.
Just how much can a lower credit score cost you? More than you might think. The difference between excellent credit and average credit can be 25-basis-points in the interest rate. That means an excellent credit score applicant might qualify for 3.75% APR while an average credit score applicant gets 4.00%. That difference may look menial, but can actually amount to several thousand dollars or more.
For example, on a $300,000 30-year home loan at 3.75%, the monthly payment (principal and interest) is $1,390. Over 30 years, you’ll pay $200,164 in interest charges.
The very same loan at 4.00% has a monthly payment of $1,432. Right away you’re out $42 a month. The real kicker? Over 30 years your interest charges will be $215,607. That quarter point just cost you $15,443. Don’t you have a better use for $15,000?
Your credit score is important. The good news is that it’s fairly simple to bring it up. Don’t be fooled – there is no quick fix or overnight patch for credit scores. These five tips work wonderfully but expect to wait three to six months before you see a significant increase in your score.
When you become an authorized user on someone else’s credit card, it shows up on your credit report. That means if the primary account holder handles the account responsibly by paying on time and keeping the balance low, you get the benefit of that positive data and your score could go up.
The risk: if the primary account holder carries a high balance or pays late, your credit score suffers, too.
Know where you stand, and get it for free. Credit Sesame offers members their free credit score, free credit report card and free credit monitoring in addition to other benefits. What that means is that you can find out right now what your score is and the reasons why.
See where you can improve. For example, if you have a “C” grade in credit usage but an “A” in the other factors that affect your score, you will need to focus on bringing down your credit balances.
If your credit score is high enough to qualify for a credit card with a 0% introductory APR or low APR personal loan, consider getting one and transferring some or all of your debt. This step can save you a ton of money on interest and help you get a handle on your high-interest debt.
Do this several months before you start shopping for mortgage rates. The number of recent applications for new credit affects your eligibility for a mortgage. Also, know that opening a new line of credit will temporarily ding your score, but your score will recover (immediately or within a year). Here’s how. If you increase your available credit without increasing your total debt, your credit utilization ratio will come down, and that’s good. You could see your score rise in the first month.
Even if your score dips a little or stays flat, credit applications are only factored into your score for one year (and their effect diminishes gradually during that time).
Your payment history accounts for the largest portion of your credit score. Not only will a late payment hurt your score, but the mortgage lender will require a letter of explanation for each late payment that shows up in your file.
A goodwill letter is a letter to the creditor asking for removal of negative marks from your report. They are most effective under extenuating circumstances (a one-time mistake, a sudden loss of income, etc.). You should definitely write your creditor a goodwill letter if a technical issue delayed your payment, such as an auto-payment that failed because you changed banks.
Send the letter by snail mail. Explain the situation and ask directly for the removal of the negative mark. Keep the letter short and to the point, but also polite. Own up to the mistake if it was yours. Don’t forget to include your account number and the date of the late payment in the first sentence of your letter.
If you have a good history with a creditor, they may raise your credit limit. This lowers your utilization ratio and can result in an immediate credit score boost.
For example, if you only have $500 of debt, but your limit is $1,000, you have a 50 percent credit utilization ratio. Increasing your credit limit to $2,000 knocks your credit utilization ratio to 25 percent, and your score should improve.
Call your creditor to ask if you are eligible for a credit increase. Be sure to ask if the increase will trigger a hard inquiry on your credit. You want to avoid a hard inquiry if you plan to shop for a mortgage in the upcoming month or two.
Don’t let the homebuying process intimidate you. Here are the answers to three common credit questions new home shoppers have.
On most credit scoring scales, 850 is the maximum score (and almost no one has it). Thankfully, many lenders do not expect that level of credit. Instead, a score over 740 is considered excellent by most lenders. When your score drops below about 700, things can get iffy. That’s where you’re likely to see higher rates. Below about 680, some lenders will take a pass on you (but you’ll still be eligible for certain government-backed loans).
The minimum credit score to qualify for an FHA loan is 580. Below that, you aren’t likely to get a loan. Even with a score of 580 it’ll be tough. Some lenders offer subprime loans for borrowers with bad credit, but
they come at a higher cost overall. In general, the lower your score the more you’ll pay.
Before settling on a subprime loan, try to improve your credit score. Give it at least a year, and longer if keeping more of your own money is important to you. The effort will be worth it.
Many lenders offer free prequalification. That means you’ll provide information about your finances and credit and the lender will tell you, more or less, what you’ll qualify for. Since the information is not verified, the lender is not obligated to honor any terms mentioned.
Once you apply for pre-approval or for the actual loan, each lender you apply with will pull your credit report (with all three credit bureaus). In fact, they’ll check your credit more than once. They’ll want to ensure that nothing significant has changed between the time you applied and the time the loan closes.
The bright side is that credit scoring models are designed to let you shop around for the best loan (which you can best accomplish by applying with multiple lenders). Inquiries are coded to the industry of the lender (auto, mortgage, student, etc.). Mortgage inquiries are totally ignored for the first 30 days. Then, all of the mortgage lender inquiries made within a certain time frame are considered one inquiry where your score is concerned. The time frame is between 14 and 45 days, depending on the credit scoring model used (the newest FICO® score gives you 45 days; VantageScore® gives you 14). To be on the safe side, do your shopping within two weeks.
Whether you’re charged a fee for credit pulls depends on the lender. Each time a lender pulls your credit, it costs them money. Some lenders charge the home buyer this fee upfront; others roll it into the closing costs.