If you're seeking the best deal on a mortgage, you'll need to give your credit some serious attention.
Your credit report and score are two essential elements used by mortgage lenders to decide whether you'll be approved for a mortgage. The information found in your credit report is used to calculate your credit score. A higher score reflects a strong credit history and can make you eligible for the lowest possible mortgage rates.
"Generally speaking, having a high FICO Score makes it more likely a consumer will qualify for favorable loan terms," says Jeffrey Scott, spokesperson for the Fair Isaac Corporation (FICO).
Lower rates mean lower monthly mortgage payments and lower interest payments over the life of your loan. In other words, you can save some major cash by improving your credit before you apply for a mortgage.
Here are eight ways you can give your credit a boost to get the lowest mortgage rates.
1. Know Where You Stand
Your first stop on the path to a better mortgage deal is creating a baseline. You have to know where you stand in order to improve. Get started by running your credit reports and getting your credit score.
By law, you're allowed one free credit report from each of the three major bureaus—TransUnion, Equifax and Experian—every 12 months.
"Managing a good credit score should be approached like an annual health exam: It is important to do this at least every year, and more frequently, if there is a change in financial condition," says Rich Arzaga, CFP, founder and CEO of Cornerstone Wealth Management in San Ramon, California.
2. Learn How Your Score Works
While you have a variety of credit scores, your FICO score is used by "90% of top lenders when making lending decisions," according to myFICO.com, the consumer division of FICO.
Your FICO score is calculated using both positive and negative information in your credit report. The data breaks down into five main categories:
- Payment history: 35%
- Amounts owed: 30%
- Length of credit history: 15%
- New credit: 10%
- Types of credit used: 10%
Every lender establishes its own criteria with regard to underwriting new loans and managing existing loans, says Scott. And credit scores are typically one factor among several that lenders consider when making decisions.
3. Fix Errors
Fixing errors on your credit report is a crucial step that can dramatically improve your score.
Michael McNamara, regional vice president for United One Resources in Wilkes-Barre, Pennsylvania, which provides rapid rescoring services for mortgage lenders, says he's seen a credit score increase by 40 points from one late payment correction.
If you find errors on any of your reports, dispute them immediately with the appropriate bureau, says Scott.
The first step is to inform the responsible credit bureau of the inaccurate information. Your dispute letter to the bureau should include copies of supporting documents, clear identification of the items you're disputing, why you're disputing the information and a request to delete or correct the error. Circle the disputed items and send the letter by certified mail, according to myFICO.com.
Next, do the same with the creditor or information provider, and explain why you're disputing the item.
Unless they consider the dispute to be frivolous, credit bureaus are required to investigate the dispute, which usually happens within 30 days, notes the Federal Trade Commission.
4. Eliminate Disputed Accounts
Credit report errors that have been disputed are labeled as disputed accounts on your credit report. And those disputed accounts have to be closed before you apply for a loan.
Disputed accounts are not factored into the overall credit profile, says Kurt Johansson, senior loan officer for Shelter Mortgage Company in Nashville.
Because of this, lenders require the borrowers to remove or resolve the disputes so an accurate score can be calculated, he says.
You can remove disputed accounts by contacting the credit bureau and information provider and asking to have the accounts removed out of dispute.
To ensure mistakes are corrected as quickly as possible, it's important to contact both the credit bureau and the lender, bank or creditor that provided the information to the bureau, says Scott. "Both these parties are responsible for correcting inaccurate or incomplete information in your report under the Fair Credit Reporting Act," says Scott.
5. Pay Down Your Debts
"Keeping your balances low can have a positive impact on your FICO score," says Scott. That's because your "Amounts Owed" category accounts for around 30% of your FICO score.
If you can swing it, paying down your credit card debt balances to at least 30% of your total limit is an easy way to give your score a bump, notes McNamara.
"In most cases, paying down revolving unsecured debt provides a positive impact on the credit scores, especially on files that have a high utilization ratio, thus allowing borrowers to obtain a better rate on their mortgage," says McNamara.
6. Pay Bills on Time
Late payments and collections leave major blemishes on your credit report, according to myFICO.com. And once you have a delinquent payment, there's not much you can do about it.
Paying your bills on time and avoiding late payment is the only way to keep a positive payment history. And the only way to improve upon a payment history is by annually reviewing your report to keep a look out for, and correct, possible errors, says McNamara.
"Credit scores are slow to improve, but very quick to drop if late payments are recorded," says Arzaga.
Johansson says that in addition to bankruptcy, foreclosure and judgments, collections and habitual late payments are the worst things to see on a credit report.
7. Use Credit Wisely
Scott says there are three golden rules for maximizing your FICO score:
- Pay all bills on time, every time.
- Keep balances on credit cards low.
- Apply for credit only when you need it.
"Do not over extend yourself," says Arzaga. "If your goal is to improve your credit score and qualify for better rates and terms, then manage your household cash flow," he says. Having better household cash flow will reduce the risk of late payments.
Another tip: Keep revolving credit card accounts to a minimum. Johansson says that seeing several revolving accounts on a credit report is a subtle red flag and, in some cases, can show the potential for overspending.
8. Don't Close Accounts
This is a little tricky, says Arzaga. "On the one hand, lenders do not want to see a lot of open credit. On the other hand, they would like to see some type of ratio of open credit to credit used."
But in general, it's never a good idea to open or close accounts prior to applying for a mortgage loan, says Johansson. It can negatively impact your score.
One way that closing an account can impact your credit score is the credit utilization calculation.
"If the balances on their remaining credit cards remain the same, then the consumer's utilization rate will increase. This may lower their FICO Score," says Scott.
The Bottom Line
Undeniably, it's always important to go into the mortgage process with the best potential credit position. Just make sure to give yourself ample time to find and correct credit report errors. As Arzaga says, it could take months. "Doing this clean-up in advance will also speed up the mortgage process," he says.
You can really improve your outlook of getting the lowest possible mortgage rates by paying your bills on time, keeping account balances low, and using credit wisely.