Your credit score is used as a risk factor in determining your mortgage eligibility. It can determine if and how much you can borrow (and at what interest rate, depending on your loan program). If homeownership is one of your 2016 goals, here are six credit habits to break to get your score mortgage-ready.
Habit #1: Not Monitoring Your Credit Report
You can’t fix (or maintain) what you don’t know. With many free credit score monitoring sites available, you may have forgotten to look at your actual credit report for inaccuracies. A 2012 Federal Trade Commission reported found that one in four credit reports contains a serious error, most commonly including inaccurate credit limits, inaccurate loan or account balances, accounts that don’t belong to you, and reported late payments that were actually on time.
Solution: As a consumer, you’re entitled to one free credit report from each of the three credit-reporting agencies (Experian, Equifax and TransUnion). If you happen to find an inaccuracy on your report, contact the credit bureau that contains the error.
Habit #2: Not Making High-Interest Debt a Priority.
Paying down debt can increase your mortgage affordability (or mortgage eligibility, altogether), because how much you are allotted to borrower is partially determined by your debt-to-income ratio.
Solution: The best strategy to paying down your debt at a faster rate (and save you tons in interest payments) is to focus on paying more than the minimum payment on your highest interest rate account while still making minimum payments for your other debts.
Habit #3: Making Late Payments…Even if it’s Just One Time.
The most important component of your credit score is payment history, and even one late payment can significantly impact your credit score. FICO considers the effect of late payments using the criteria of:
- How recent the late payment(s) occur
- How severe the late payments are
- How frequently the late payment(s) occur
According to FICO data, a 30-day delinquency can cause your credit score to drop as much as 90-110 points for a consumer with a 780 credit score who has never missed a payment previously.
Solution: Consider automatic payments or put a reminder on your calendar several days before the bill is due. Most creditors offer direct auto-billing. If you know you are going to be late with a payment for extenuating circumstances, contact your creditor to work out a payment plan. If it’s your first time paying late, some creditors are willing to forgive a one-time late payment occurrence.
Habit #4: Regularly Maxing Out a Credit Card.
The amounts owed on your credit accounts is the second largest factor in determining your credit score. While carrying a balance doesn’t necessarily mean you’re a high-risk borrower, when a high percentage of your credit lines are in use or “maxed out”, this can indicate a borrower who is financially overextended and more likely to miss a payment.
Solution: Aim to keep your revolving credit below 30% of your credit line. Ideally, keep credit utilization below 10%. Having a low credit utilization ratio usually results in a higher FICO score.
Habit #5: Making Only Minimum Payments.
While making the minimum (on-time) payment for your credit accounts isn’t necessarily a mistake, you likely aren’t doing yourself any favors. Most creditors only ask for 1-3% of the account’s total balance, which is why your balance hardly budges if you’re only making the minimum payment.
Solution: Pay special attention to the amount of interest you’re accruing each month in comparison to the minimum payment amount. If your credit cards all have similar interest rates, pay the minimum plus interest on a monthly basis to lower your credit utilization ratio and save big on interest.
Habit #6: Avoiding Establishing Credit Altogether.
No credit is not good credit. While some loan programs allow non-traditional forms of credit (i.e. cell phone and utility bills and rent) to show a borrower’s financial responsibility, having at least some credit history is beneficial.
Solution: If horror stories of people drowning in credit card debt have scared you away from establishing credit, there are plenty of responsible ways you can do so. Open up a credit card with a low credit line and use it to make one type of monthly purchase, like groceries or gasoline. Pay it off each month to eliminate your fear of becoming debt-ridden.
If you’re wishing to make a purchase now or in the near future, make sure you aren't relying on the scores given by online credit checks. When Compass Mortgage runs your credit score, we gather all three FICO scores from Experian, Equifax and TransUnion. We then take the median score of the three to represent your score throughout the mortgage process.
Online checks typically only represent one of your three scores and could misrepresent where your credit stands for mortgage financing.
To learn more about credit and the role in plays in home financing, download our free Mortgage 101 Handbook, a great resource for first-time homebuyers.