When you’re looking to buy a home, your credit score is one of the most important factors that will influence the type of mortgage you qualify for, the interest rate you receive, and your overall borrowing power. A higher credit score can make it easier to qualify for a mortgage with better terms, potentially saving you thousands of dollars in interest payments over the life of the loan.
If your credit score isn’t where you want it to be, don’t worry! There are several steps you can take to improve your credit score before applying for a mortgage. In this article, we’ll explore how your credit score impacts your mortgage, and provide actionable tips on how to boost it.
1. Understanding How Credit Scores Affect Your Mortgage
Your credit score plays a significant role in the mortgage approval process. Lenders use your credit score to assess your creditworthiness and to determine how risky you are as a borrower. The higher your score, the more likely you are to receive approval for a loan with favorable terms, such as a lower interest rate.
Here’s how your credit score affects your mortgage:
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Interest Rates:
Borrowers with higher credit scores are typically offered lower interest rates. This is because they are seen as less risky to lenders. Even a small difference in interest rates can significantly impact your monthly mortgage payments and the amount you pay over the life of the loan. -
Loan Approval:
Lenders set credit score thresholds for different types of loans. For example, you may need a credit score of 620 or higher to qualify for a conventional loan. FHA loans may have more lenient requirements, while VA and USDA loans also have specific credit score guidelines. -
Down Payment Requirements:
A higher credit score may also reduce the amount of money you’re required to put down on your home. Lenders may offer more favorable down payment terms for borrowers with higher scores. -
Mortgage Insurance:
With a low credit score, you may be required to pay higher premiums for private mortgage insurance (PMI), which is required if you’re putting down less than 20%. A higher credit score can help you avoid PMI or reduce its cost.
2. Check Your Credit Report for Errors
Before making any changes to your credit habits, it’s a good idea to get a copy of your credit report to ensure that there are no errors or inaccuracies. Mistakes on your credit report can lower your score, and disputing them can have a significant impact on your credit score.
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How to Get Your Credit Report:
You are entitled to a free credit report from each of the three major credit bureaus (Equifax, Experian, and TransUnion) once every 12 months through AnnualCreditReport.com. -
What to Look For:
Review each section of the report carefully. Common mistakes include incorrect account information, accounts that don’t belong to you, or outdated negative information. If you find an error, contact the credit bureau to dispute it and have it corrected. -
Correcting Errors:
The credit bureau is required to investigate the dispute and correct any errors within 30 days. Removing negative or inaccurate information can result in an immediate boost to your credit score.
3. Pay Your Bills on Time
Your payment history makes up a significant portion of your credit score—approximately 35%. Missing payments or making late payments will have a negative impact on your score, and the more recent the missed payment, the bigger the effect.
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Why It Matters:
Timely payments show lenders that you are a reliable borrower who can be trusted to repay your debt. Late payments, on the other hand, signal to lenders that you may be a high-risk borrower. -
How to Improve Your Payment History:
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Set up automatic payments: Consider automating your bill payments to avoid missing deadlines.
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Use payment reminders: Set reminders on your phone or calendar to alert you when payments are due.
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Catch up on overdue bills: If you have overdue bills, pay them off as soon as possible and bring your accounts current.
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What If You Missed a Payment?
If you’ve missed a payment, it’s still worth working on improving your payment history. If you’ve only missed one or two payments, paying on time going forward can help your score improve over time.
4. Reduce Your Credit Utilization
Credit utilization refers to the percentage of your available credit that you’re using. It’s an important factor in your credit score calculation, making up about 30% of your score. Ideally, you should aim to keep your credit utilization below 30% of your total available credit. For example, if you have a total credit limit of $10,000, you should aim to carry no more than $3,000 in balances.
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Why It Matters:
High credit utilization can indicate that you are overextended and may be at risk of defaulting on your debts. On the other hand, low credit utilization demonstrates that you’re using credit responsibly, which can boost your credit score. -
How to Reduce Credit Utilization:
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Pay down existing balances: Focus on paying off credit card balances, especially those with high-interest rates.
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Increase your credit limit: If you’re able to, request a credit limit increase. This will automatically lower your credit utilization ratio, even if your spending habits stay the same. However, avoid increasing your spending.
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Pay off balances more frequently: If you’re consistently carrying a balance on your credit cards, consider paying them off more frequently throughout the month to keep your utilization low.
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5. Avoid Opening New Credit Accounts
Each time you apply for a new credit account, the lender will conduct a hard inquiry on your credit report. Hard inquiries can cause a temporary dip in your credit score, and too many of them in a short period can make you appear risky to lenders.
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Why It Matters:
Multiple inquiries in a short period can suggest that you’re experiencing financial difficulty or may be overextending yourself. Opening new credit accounts can reduce the average age of your credit accounts, which can negatively impact your score. -
How to Avoid This:
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Limit credit applications: Only apply for credit when absolutely necessary, especially in the months leading up to your mortgage application.
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Shop around wisely: If you need to compare mortgage rates, do so within a 30-day window. Multiple inquiries for the same type of loan (like a mortgage or auto loan) within this period typically count as one inquiry.
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6. Pay Down High-Interest Debt
Having a lot of high-interest debt can lower your credit score because it may increase your credit utilization ratio and make it more difficult to keep up with payments. Paying off high-interest debts, such as credit cards, will not only improve your credit score but also free up more of your income for other financial goals.
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Why It Matters:
Reducing your overall debt load can improve your credit utilization ratio and show lenders that you’re actively working to reduce your liabilities. This can increase your chances of securing a mortgage with favorable terms. -
How to Pay Down Debt:
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Debt snowball method: Focus on paying off your smallest debts first, while making minimum payments on larger ones. This creates momentum and motivation as you pay off each balance.
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Debt avalanche method: Focus on paying off high-interest debt first to save money on interest charges over time.
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7. Consider a Secured Credit Card or Credit Builder Loan
If your credit score is particularly low or you have a thin credit file, a secured credit card or credit builder loan can be an effective way to boost your credit score. These products are designed to help individuals build or rebuild their credit.
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Secured Credit Cards:
A secured credit card requires a cash deposit that acts as collateral. The deposit is typically equal to your credit limit. By using the card responsibly and paying your balance on time, you can gradually improve your credit score. -
Credit Builder Loans:
A credit builder loan is a small loan that you borrow and repay over a set period. Your payments are reported to the credit bureaus, helping to establish or improve your credit history.
8. Monitor Your Credit Score
Improving your credit score takes time, but monitoring your progress can help keep you motivated and ensure you’re on track. Many financial institutions, credit card companies, and third-party apps offer free credit score tracking services. Regularly checking your score allows you to identify any negative trends and make adjustments as needed.
9. Conclusion
Improving your credit score before applying for a mortgage is one of the most effective ways to secure a better mortgage rate and save money over the life of your loan. By checking your credit report for errors, paying your bills on time, reducing your credit utilization, and taking other steps to improve your credit, you can increase your chances of qualifying for a mortgage with more favorable terms.
The key is to start early—ideally months before you begin house hunting—so that you have time to make meaningful improvements to your credit score. If your credit score is already in good shape, you’ll be in a strong position to secure the best mortgage rates available.