Applying for a mortgage is all about numbers, particularly when it comes to your credit score.
The higher your score, the less lenders perceive you as a financial risk and the better your interest rate. And the better the interest rate, the lower your monthly payments. Plus, you’ll pay less over the life of the loan.
If you’ve discovered your credit score is lower than you thought, don’t panic. There are ways to increase it before you apply for a mortgage. But don’t expect a quick fix — it could take several months or longer.
“There’s no easy way to improve your score overnight,” said Mike Sullivan, chief education officer for Take Charge America, a national non-profit credit-counseling and debt-management agency that’s based in Phoenix.
Before we get into the nitty-gritty of improving credit scores, let’s take a look at the numbers.
Credit scores, also called FICO scores, range from 300 to 850. Most credit scores are between 600 and 750, according to Experian.com.
A score of at least 580 is needed to get a mortgage that is insured by the Federal Housing Administration, but you might be able to get a mortgage with a lower score, Sullivan said.
Generally, however, you need at least 620 to 640 to get a mortgage, said Carla Hancock, senior loan officer with Nova Home Loans’ Camelback office.
For every 20-point improvement, you may qualify for a lower mortgage interest rate or lower mortgage insurance rates, she said.
A very good score is considered to be 720 or higher.
Let’s also take a look at percentages. A credit score is impacted by five factors, each of which contributes a certain percentage of the total score. They are:
• Payment history. This makes up 35 percent of the FICO score.
Have you paid your bills on time in the past? Did you miss any payments? This is one area you can’t fix or change.
• Amounts owed. This makes up 30 percent of the score.
How maxed out are your credit accounts? If you owe a high percent of your available credit, it may signal that you’re overextended and may have a harder time making timely payments.
• Length of credit history This is 15 percent of your score.
Have you had your credit card for a long time?
• New credit. This makes up 10 percent of the score.
If you’ve just opened a new account or bought a new car, this can negatively impact your score.
• Types of credit used. This is 10 percent of the score.
A variety of types of credit is best. For example, having two credit cards and a car loan is preferential to three credit cards, Sullivan said.
So, what can you do to improve your FICO score to get a better mortgage interest rate?
• Pay your bills on time. You can’t improve your past payment history, but you can start paying on time from here on out.
If you have problems remembering to pay the bills, set up reminders on your smartphone or sign up for automatic payments.
If you are behind on payments, catch up.
• Pay off your credit cards as best as you can.
• Lower your utilization rate.
The utilization rate is the ratio between the amount of credit you owe and your credit limit.
The lower the utilization rate, the better, Sullivan said. A high utilization rate can adversely affect your score.
Let’s say you owe $10,000 on five credit cards. The cards have a total amount of credit of $50,000. That means your utilization rate is 20 percent. But if the total amount of available credit on those five cards is $15,000, your utilization rate is 66 percent.
“Balances on revolving debt should remain below 30 percent of the credit limit,” Hancock said. “If your credit limit is $2,000, don’t carry a monthly balance that exceeds $600.”
If you pay off your balances every month, you could still have a higher-than-expected utilization rate. Credit-card issuers submit data to credit-reporting agencies. If the issuers submit your statement balances before you’ve paid them off, your utilization rate will be higher.
• Don’t open a new line of credit that you don’t need just to make it look like your utilization rate is lower.
• Don’t close a line of credit even though you aren’t using it. If you do, you are erasing payment history that could improve your credit score.
• Get a copy of your credit report and fix any errors on it.