If you hope to get a mortgage, either for a new house or to refinance into the great low rates available now, the biggest factor that you can control is your credit score. Your FICO credit score -- a number that gives lenders an idea of how well you pay bills, live within your means and manage debt -- will determine how good of a rate you get or whether you get a loan at all.
If you have a score of 740 or above, you'll get the best rate. Below that, it's a sliding scale. Above that you're not going to do much better, so don't obsess.
The FICO score isn't magic; it's a mathematical formula. But while some will try to game the system with short-term, expensive gimmicks, the cheapest and most effective way is to just start paying your bills when they are due, says Gail Cunningham spokesperson for the National Association of Credit Counselors.
"Financial stability is not rocket science," says Cunningham. "The biggest element is paying your bills on time."
She means that literally. There's no secret formula; the information is all public. For example Experian offers credit score basics detailing how scores are calculated. Different reporting agencies may use slightly different percentages, but it boils down to roughly this:35% Paying Bills On time
30% How Much You Owe and How Much Credit You Have
15% How Long You've Had the Accounts
10% No New Accounts
10% Variety of Accounts
Use automated bill payment
Lots of people have the money to pay their bills; they're just too disorganized to do it. "Know yourself and know if you're a procrastinator," Cunningham says. Automated bill payment is usually free, and some banks will even send out paper checks automatically to people you owe who don't take electronic bill payment.
It's especially helpful for credit cards, which are now scrounging for every fee they can get. And, most importantly, you won't get a ding on your credit report for being late.
Pay down your credit card debt
Lenders don't want you to use more than 30% of your overall credit limit. Just because someone is willing to lend you money, doesn't mean you should take it.
"They'll allow you to charge 100% or more because they can add extra fees," Cunningham says. For a credit card company, someone who keeps a high balance and barely pays the minimum is the ideal customer; they generate the most fees. But for a mortgage lender, that person is a higher risk.
"Getting below 40 is okay. Thirty is better," says John Holmgren, spokesman for the California Association of Mortgage Brokers.
You also don't want to concentrate all your balance on one card, no matter what miles or rewards you're soaking up. Creditors look at your overall available credit and whether you are at your limit in any one account.
Get Your 2010 Credit Score
Don't open or close accounts just before you buy
If lenders only want you to use 30% of your credit, there's a painless solution: get more credit. Right? Wrong. Opening or closing any credit cards near the time you want to apply for a mortgage, will hurt your score.
"Don't go out and try and get new credit everywhere," Cunningham says. "It looks like you're desperate and don't have cash to pay for anything."
Cunningham says she sometimes has to talk people down from canceling a card after the bank charges some outrageous fee. The one you'll be punishing is yourself. Do you really think bank executives sit around mooning over a handful of closed consumer accounts? Not likely.
"They think in punitive terms, they get so mad," Cunningham says. "They have a knee jerk reaction and close the account." But that lowers their overall credit limit and it hurts another factor in the credit score: the longevity of your accounts.
Living well is the best revenge: set up automatic payments so you never pay a late fee. Keep the account open to suit your purposes. Make only a few token purchases to keep the account open. After you get your mortgage you can wage your personal crusade against unfair credit card fees.Mix it up
Lenders like to see that you can handle different kinds of debt and bills: fixed payments (mortgage, car payments, student loans) and revolving credit (credit cards). That shows you're disciplined and responsible.
You can improve a low score faster than a high one
With a little work you improve a low score, but if you've already got great credit and want to prove you have perfect credit, it's going to be as tough as losing those last 10 pounds.
"Time is your best friend. You can move pretty quickly or significantly if your score is low 600s," Cunningham says. "If you have a 750 and have your heart set on 800," that will be harder.
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"No one can improve your credit legally with anything that you can't do yourself," Cunningham says. Don't fall for credit doctors or clinics, especially those that charge thousands of dollars.
"So many times I've heard of mortgage brokers trying to game the system," she says. They will flood credit agencies with disputes, which legally have to be responded to within 30 days or the negative events have to be removed. Just after 30 days the broker pounces. "That's how a lot of people got into these loans that came back to bite them."Do get your credit report and dispute mistakes
The U.S. Public Interest Research Group found that 79% of credit reports have a serious error and one in four reports has an error so bad it would prevent someone from getting credit. The Federal Reserve reports that the problems seem to be concentrated on the young. For example, nearly one in five accounts of a consumer under 35 had a data problem with a medical collection account.
You can get one free report a year from each of the three major credit reporting agencies. The only authorized source, according to the Federal Trade Commission, is AnnualCreditReport.com. Just go to the site and order your credit reports from each of the agencies free. You can get them all at once, but you may want to stagger them so you can keep on top of any problems.
For a young person it can take years of making money and paying bills to build up credit, Cunningham says. John Holmgren, spokesman for the California Association of Mortgage Brokers says sometimes he'll tell people just to try again in a few months if some temporary cloud is hanging over them, like one partner losing a job.