What is my credit score and how do I improve my credit score?
Home buyers need to know what their credit score is before they begin the process of shopping for a home. I often refer clients to Credit Karma, a free service and useful tool in determining your credit worthiness – and how to improve your credit.
You can contact a Lender and go ahead and make an application if you have a good idea of what your credit score is. However, if you are in doubt, it’s helpful to do a little preparation before a Lender makes a hard inquiry of your credit score. A higher credit score could result in a better interest rate.
What is a hard inquiry of your credit score?
A hard inquiry, also known as “hard pull,” occurs when a Lender pulls your credit to see if you qualify for a home loan, automobile loan or credit card. It may or may not negatively affect your credit score, but multiple hard inquiries may raise a red flag.
Factors considered in determining your credit score
Several factors determine your credit score including (1) credit card utilization; (2) payment history; (3) derogatory remarks; (4) credit age; (5) total accounts; and (6) number of hard inquiries.
Credit card utilization
This figure is the amount of your credit card balances in relation to your total available credit. If you have 2 credit cards with a TOTAL credit limit of $2,000 and your total balance between the two is $500, that would represent a 25% utilization. This factor is a high impact in determining your credit score. The OPTIMUM balance should be less than 30% utilization.
This is why you don’t want to cancel credit card accounts that you are not using. I took out a credit card at a flooring store several years ago and it has a $5,000 limit. They were running a special that if the balance was paid in full within 12 months, there was no interest charged. So, I made my purchase, paid the balance within the allotted time and now have a zero balance. Even though I don’t plan to purchase additional flooring, I did not cancel the account because that $5,000 limit is included in my total available credit. That helps me keep my credit card utilization under 30% even if I owe more than 30% on any particular card.
This is a history of your on-time and or late payments. It has a high impact on your credit score, so if your credit score needs improvement, this is a critical area to improve. A 100% on-time payment history is going to provide any Lender an indication that you can and will reliably make payments to them. Even if you are only able to make a minimum payment on your credit card, try to make it a few days early. Sometimes there are delays in posting payments, so don’t leave yourself open to late pays or fees for late payments. Pay early and often!
Derogatory remarks can stay on your credit report for 7-10 years, so avoid them! They may include collections, foreclosures, garnished wages or other public records. This has a high impact on your credit score.
Although this has a medium impact on your credit score, it’s not a quick fix. If the age of your credit history exceeds 7 years, this tells your Lender that you have exercised your ability to pay your debts consistently. Credit age less than 4-5 years does not establish the same history of credit worthiness. If your credit history is young, keep your accounts open and continue to make timely payments.
This one seems a bit puzzling to me, but Lenders want to see at least 11 open accounts. This shows that you have used a variety of accounts responsibly. In addition to a mortgage payment and automobile payment, I also have an equity line of credit that I never use. If you need to build your accounts, do so slowly. Instead of opening several Visa and Master Cards, it may be easier to add a Lowe’s or Target card. The factor of total accounts has a low impact on your credit score.
Although this has a low impact on your credit score, it is something to be mindful of. And, if you understand how it works, it’s easy to avoid mistakes. One feature of Credit Karma is that is will estimate your approval odds of getting a credit card BEFORE you make the application. If the approval odds are not high, follow their recommendations before applying and resulting in an additional hard inquiry.
Credit Score Simulator – helpful tool in improving your credit score
This is my favorite feature on Credit Karma. It allows you to run several “what if” scenarios. In my case, my credit card utilization recently crept above 30%. I can go to the option to “increase or decrease credit card balances.” I put in several figures of the amount I should decrease my total credit card balance until I found the sweet spot that would get my score back up where I want it.
Other options under the credit score simulator include “What might happen if get a new loan, open a new credit card, close your oldest card, etc.” Be mindful that the simulator is not an exact science and provides estimated outcomes – not guarantees.
Prevent Credit Fraud
Constant monitoring of your credit can alert you to possible financial breaches or identity theft. Stay on top of it. You can and should check your credit often and for free.
Credit Score is only 1 piece of the puzzle – Debt-to-Income Ratio
A mortgage Lender is going to consider several factors to determine how much you can spend on your home. General rule of thumb is that your debt-to-income ratio must be 43% or lower. To calculate this, add up all your monthly debt and divide by your gross income. For example, if total monthly bills are $2000 and total monthly income is $6,000, your ratio would be 33%. This figure is important to Lenders because it’s an indication of your ability to repay your loan. The higher your ratio, the less likely you are going to be prepared should you need to repair a broken automobile or survive a missing paycheck due to illness.
It goes without saying that having a history of four years on the job versus 4 months on the job provides the Lender with some comfort that you will keep your job and thus improve odds of your ability to pay back your debt.
With so many resources available online, educate yourself and be prepared to speak with a Lender before you begin to shop for a home. I would prefer to see my step-daughter rent for another year and build up her savings account before purchasing a home. Owning a home is a wonderful feeling and adventure, but if you can’t afford to repair your broken air conditioner during a hot Oklahoma summer, that spoils the fun! Have a nest egg in place before you take the plunge!
If I can assist you in your home purchase or help you improve your credit score, please do give me a call! 918-852-5036
Content written and published by Lori Cain.
Lori Cain is a residential Realtor with eXp Realty serving the greater Tulsa Oklahoma area. Call 918-852-5036. eXp Realty is the Agent-Owned Cloud Brokerage®!