So you're thinking of buying a house, but you're afraid your credit score isn't quite up to snuff. You may be asking yourself, "How much house can I afford?" and "Can I even buy a home with my current credit score?" You're not alone.
In today's tight economy, more than 25 percent of consumers -- an estimated 43.4 million people -- have a credit score of 599 or below, according to recent numbers released by FICO. "And while the FHA program will write mortgages with the same great interest rates all the way down to a credit score of 580, other low-rate offers will generally require a score of 720 or higher," said Keith Gumbinger, Vice President of HSH.com.
You'll be offered better mortgage rates with a higher credit score, says Gumbinger, and that translates into savings. Get offered a 6 percent rate instead of 5 percent on a $200,000, 30-year mortgage, and you'll wind up paying about $125 more each month.
Here's what you can do to raise your credit scores and get on the path to home ownership.
Know how your score works
Your overall credit score is made up of several factors, and each is weighted differently. Since different credit behaviors can have different effects on your score, it's important to know how they works.
Here's the breakdown of which factors affect your credit score:
- Payment history (35 percent)
- Amounts owed (30 percent)
- Length of credit history (15 percent)
- New credit (10 percent)
- Types of credit used (10 percent)
Get credit savvy
Think about how your financial behavior affects your credit score. Do you carry a balance on your credit cards? If so, that hurts your score in terms of amounts owed. If you open too many new lines of credit, mortgage lenders will see you as desperate. Making late payments causes creditors to think you're insolvent. These are all things that will drop your credit score.
Check your status
"You'll want to review your credit reports six months or more before a large credit event like applying for a mortgage," says Gumbinger. It can take quite some time to clear up any errors or solve legitimate disputes, and you want those things off your report when you fill out mortgage applications.
Even if you're not in the market for a mortgage, you'll still want to review your credit reports at least once each year. You're entitled to one free credit report from each of the three major credit bureaus (Equifax, Experian and TransUnion) each year. Stagger receiving the reports, and you'll have a credit update once every four months. You can access your free reports at www.annualcreditreport.com.
Pay on time
"Be extra careful to make each [of] your minimum payments on time each month," says Barry Paperno, product support manager for FICO, inventor of the FICO score. "If you're late making payments now, bring them current immediately and keep them current." Your payment history makes up the largest part of your credit score (35 percent), and it takes longer to raise your score after late payments than it does for some other issues.
Pay down debt
Since the FICO formula looks at your credit card limits and balances, both individually and in total, shifting balances around won't make your bottom line look any better. Instead, you'll want to pay down balances while continuing to use the cards, says Paperno. Ideally, you'll want to aim for a utilization percentage, both individually and in total, of under 10 percent. That means you're using less than 10 percent of available credit on any one of your cards.
Don't close accounts
Length of credit history is another important part of your credit score, so closing old accounts could actually hurt you. That's because potential mortgage lenders want to know you've been responsible with credit for a good long time. Keep older accounts active by making small charges on each one at least every few months and then paying those charges off right away, advises Paperno. "Using your cards regularly keeps them active, which ensures that your credit limits on these cards continue to be open and included in your credit utilization. Contrary to popular belief, you won't be penalized for having lots of available credit.
Alexandra Kay is a freelance writer and researcher who has been contributing to magazines for ten years. Her previous experience includes three years as staff researcher for World News Tonight Saturday/Sunday. Alex holds a master's degree in print journalism and a second master's in teaching English.