It's easy to get stuck without a mortgage approval or with a smaller home loan than you want, just because you don't understand how your credit score works. Most of the things you've done to prepare: budgeting your income, balancing your bank accounts and saving up for a down payment, aren't reflected in your FICO credit score. It doesn't even show how much you can afford.
So what’s the point of your credit score?
It tells your lender what you’ve done with your previous credit. Whether anyone has been willing to lend you money, how long you’ve kept it and whether you pay it back on time. They keep the actual algorithm at FICO secret, but there are two main factors that you can affect.
Late Payments
These are easy to understand and fix. Ready? Pay them on time. That’s it. Each time you are late on a debt payment, whether it’s a credit card, school loan, mortgage, or car loan it dings your credit score. That’s the easy part. Now for some finance math.
Debt to Credit Ratio
Surprisingly, you are in complete control of this part of your score too. While it sounds like this is a ratio of how much you owe to how much you make, it's not. The debt-to-credit ratio shows how much you owe based on how much credit you currently have available. That means if you have a $5000 credit card, and your friend has a $2000 credit card, and you both OWE $2000, you will have a higher score than your friend because your ratio ($2000/$5000) is lower than hers ($2000/$2000). The higher this ratio gets, the less likely lenders are to give you more credit. Most professionals suggest you try to keep your usage below 30%. That means your balance on that $5000 credit card should stay below $1500. This practice works better for you as well, keeping some cushion in your accounts for emergencies.
Managing your Debt-to-Credit Ratio
There are a few tricks beyond merely using less of your credit to help keep this number under control. First off, pay off as much of your debt as possible. You want to keep that used debt down as low as possible when trying to apply for new debt. Second, don't close your paid-off accounts. While it may seem like the optimal thing to do, remember that total credit number? You want to keep that number high so that your used credit appears lower. So, you've paid off that credit card? Great! Now chop it up or put it in a hidden drawer and keep that available credit without using it. Lastly, be careful about opening new accounts. While it lowers your debt-to-credit ratio as long as you don’t actually spend from them, your score also reflects the age of your accounts. The longer ago you applied for and got credit, the more likely it is you will qualify for new credit. Don’t waste that new credit qualification on anything else besides your home loan.
Want to know the best lenders to apply with once you've got the best score? Ask your real estate agent for their top recommendations for your situation and use their expertise to ease the qualification process.
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