Why are credit scores getting slammed? A key component of your credit score is credit card utilization. You can calculate your utilization by totaling all outstanding charges and then dividing that number by the total of your credit limits. For example, if you have $5,000 in outstanding charges on two credit cards with a credit limit of $5,000 on each card for a total of $10,000, then your credit card utilization is 50 percent ($5,000/$10,000 = .50).
If you're like most people you probably had much higher credit limits prior to 2008 when credit was flowing freely. You may have had a credit limit of $10,000 or $15,000 per card rather than the current limit of $5,000. In that case your credit utilization ratio would have been 25 percent ($5,000/$20,000 = .25) or 17 percent ($5,000/$30,000 = .17).
Ideally, to get the best credit score, your credit card utilization should be between 10 percent and 20 percent. So if you're regularly running a higher percentage, you need to cut that usage at least until you close a new mortgage. This is true whether you're buying a home or looking to refinance.
You can check your credit score for free at Credit Karma.com. If it's lower than 720, you should work on improving that score before trying to apply for a purchase or refinance mortgage.
If you're someone that pays his credit card in full each month, you can quickly
You can also call your credit card companies and see if they will consider increasing your credit limits. While this was just about an automatic no in the past couple of years, reports are that credit card companies are offering new credit to people who pay their bills on time. It's worth a call, even if you don't need the additional credit. By having a higher credit limit, you can improve your credit utilization ratio.
If your utilization is high because you're carrying a balance month to month, you can still improve your score by making your payment prior to the closing date on the account. The balance reported to the credit card reporting agency will be lower and your credit utilization will gradually drop. The faster you can pay down that debt, the faster your credit score will improve so you can take advantage of the historically low mortgage rates.
Some people may advise you to close accounts in order to improve your credit score. Usually, that is a big mistake. When you close an account you loose that approved credit limit. So suppose you had three cards with a total of $10,000 available credit and you closed a card with a $3,000 credit limit. Your available credit would then only be $7,000 and your credit utilization ratio could jump dramatically. For example, suppose you carried $2,000 in debt on your credit cards. That would be a 20 percent ($2,000/$10,000=.20) credit utilization ratio. If you closed a card with a $3,000 credit limit, your credit utilization ratio would jump to 29% ($2,000/$7.000 = .29) and your credit score would tumble.
Your utilization may not be the only thing holding down your credit score. If you have past due bills, even if it's a small medical bill, that too can lower your score 50 to 100 points. So clean up any negatives on your credit report. You can check your report for each of the credit reporting agencies once a year for free at Annual Credit Report.com. Make sure there are no errors on the report and correct any you see.
As you work on improving your credit score, watch the trend of the improvements at CreditKarma.com. When your score is above 720, you then have a much better chance of getting good mortgage offers.
Lita Epstein has written more than 25 books including The Complete Idiot's Guide to Improving Your Credit Score and The Complete Idiot's Guide to Personal Bankruptcy.
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