When you’re planning to buy a home, getting a mortgage requires special attention. The mortgage you end up with might be the biggest debt transaction of your life, and getting the best interest rate possible can save you some serious money over the years.
For example, if you take a $300,000 mortgage at 4.0% for 30 years, you’ll make $515,610 in total payments. But if that rate goes up to 4.25%, your total payment ends up being $531,295.20. That’s an extra $15,685.20 over the life of the mortgage, just by raising the interest rate by a quarter of a percent.
One of the biggest factors that will determine the interest rate on your mortgage is your credit score. To that end, it's recommended to improve your score in the years before you want to purchase a house. But even if you’re just a couple of months away from homeownership, there’s still time to get your credit up.
To boost your credit score legitimately, it is best to begin by addressing the five criteria of what makes a good score.
Focus on the five credit score categories
Your credit score is calculated based on five categories, each of which makes up a specific percentage of your score. If you have limited time or resources, focus on the biggest categories. That said, all categories earn you credit score points, which will get you closer to your best mortgage interest rate.
1. Payment history (35% of score)
Payment history is the largest portion of your credit score. Other than disputing erroneously reported late payments on your credit report, the only thing you can do is make all your payments on time going forward, which you should aim to do anyway.
2. Amounts owed (30% of score)
“Amounts owed” is the second largest portion of your credit score. You can take actionable steps here to improve your score – in particular, you’ll want to owe as little as possible.
To improve your score in this category, keep your credit-utilization ratio low on your credit cards. You definitely don’t want to have any maxed-out plastic, since it can negatively affect your score.
If possible, try to keep your balances at zero by paying them off just before your statement date. Usually, the amount owed on your credit report is the same as your statement shows. So making timely (or early) payments to your credit card company can have a direct positive impact on your overall score.
3. Length of credit history (15% of score)
Length of credit history is a smaller category but an easy one to maintain. Avoid applying for new credit before taking out a mortgage – new cards will reduce the average age of all your credit accounts.
“You need to build a credit history so lenders can determine how likely you are to repay your debts on time,” says credit industry analyst Nathan Grant of Credit Card Insider.
“A longer history with a diverse credit mix of credit accounts, such as a variety of credit cards, student loans and auto loans, can show more experience handling payments,” Grant adds, “and therefore can be more impactful when applying for personal loans or a mortgage.”
Want to lengthen your credit history? If you have a friend or a family member with an old credit card, it may help to be added as an authorized user on that account. Sometimes that history transfers to you, increasing the age of your oldest account, and raising the average age of your total credit history.
Additionally, if you only recently acquired a credit card, but have a long experience in paying key expenses in a timely fashion, you can incorporate those payments into your credit score through some additional steps.
“Many people don’t realize that certain monthly payments such as rent, cell phones, utilities and insurance do not show up on their credit bureau reports,” indicates Marco Buhlmann, co-founder of credit building app Zingo.
“Unless you ‘make it happen’ yourself, you will not get credit for these monthly payments.”
By taking the initiative, you can build and lengthen your credit history and strengthen your credit score, ensuring you’ll benefit from all perks of good credit when applying for a large loan or mortgage.
4. Credit mix in use (10% of score)
Your credit mix is a small portion of your score, but every point counts. Aim to have a mix of credit cards and installment loans on your credit report.
5. New credit (10% of score)
New credit is super simple to manage before getting a mortgage. Try your best to avoid applying for any new credit for at least a few months before you apply for a mortgage. If possible, try to wait a year before opening any new accounts.
Even 0.125% makes a difference when it comes to mortgage interest rates. Working on your credit score before applying for a mortgage may save you a few eighths of a percent – and thousands of dollars over the life of your loan.
Make sure your credit report is accurate
The first thing you should do is get access to your credit reports for free. You can do this once every 12 months for each of the three major credit bureaus – Equifax, Experian and TransUnion. The information on your credit report is exactly what credit-scoring companies use to calculate your score.
Once you have your credit reports in front of you, make sure everything on them is accurate. Keep an eye out for any negative information on your reports to verify its accuracy.
If there is a negative item on your report (these include late payments, debt collections, repossession, charge-offs, foreclosure, bankruptcy and tax liens) and that information is incorrect, dispute it immediately. The same goes if you discover you’ve been a victim of identity theft.
You can try disputing the item with the creditor directly, but you’ll also want to file a dispute with the credit bureau from which the report was pulled. This is where maintaining detailed financial records is essential. Make your case with proof, and be honest during the dispute for the best chance of success.
The importance of improving your score legitimately
Many people may be tempted to do out-of-the-box things to raise their score. They might ask their parents to add them as authorized users on their cards. They take out a loan hoping it will boost their score. Some “strategically” open new lines of credit.
In the short term, as you aim for a mortgage, these things can and do work, but it isn’t always recommended if you’re looking for long-term improvement.
It’s easy to understand why some people look for credit shortcuts when trying to raise their credit score for a mortgage. Many people want to hack life. Others want results with minimal effort.
When dealing with credit, there is no shortcut for improving your score.
Sometimes we need to look at situations from someone else’s perspective. Like your banker, for example. When the loan officer pulls up your credit report, what would they like to see? Someone who is bouncing around getting random loans, opening lines of credit, not paying loans off quickly and carrying balances; or someone who pays off their small debts consistently?
4 ways to improve your credit score
But when time isn’t on your side, there are a couple of measures you can take to boost your credit score in the short term. Consider the following four strategies if you need a boost as soon as possible.
1. Become an authorized user
As stated earlier, being added to a longstanding credit account can lengthen your credit history and improve your score. But both you and the account holder need to be wary. If they aren’t as financially responsible as you think, your plan can backfire and both credit scores could suffer.
2. Request a credit limit increase
You can ask your credit card providers to increase the limits on all the cards you own. If you have a history of timely payments with your credit card provider, there’s a good chance they will negotiate. This will improve your credit-utilization rate, which is the amount of debt you’re carrying versus your total credit limits and is a major contributing factor to your credit score.
3. Pay down your cards
Your credit-utilization rate will also improve if you pay down your credit card balances. If you have some extra funds, consider making extra payments on your credit card as soon as possible. Try to keep your utilization rate under 30 percent of your limit.
4. Request a rescore
One lesser-known trick is to ask your lender about a rapid rescore. Rapid rescoring services are usually provided by mortgage lenders when applicants are on the cusp of qualifying for a better interest rate. Rapid rescoring can help update credit reports or fix errors quickly, which can help if you plan on applying for a mortgage in the near future.