How to Maximize Your Credit Score Prior to Obtaining a Mortgage!
As a consumer, your personal credit score determines what type of interest rate you will qualify for when attempting to borrow money. This is true for any type of loan or credit you may try to qualify for including car loans, a mortgage or even credit cards. This is why it's important to have the highest possible credit score when applying for any type of financing.
Before we get into the specifics on how to maximize your credit score, I want to help you understand how credit scoring works. I've included a graph below that displays the credit scoring factors and how much they affect your credit score.
35 percent of the score is based on your payment history. This makes sense since one of the primary reasons a lender wants to see the score is to find out if (and how promptly) you pay your bills. The score is affected by how many bills have been paid late, how many were sent out for collection and any bankruptcies. When these things happened also comes into play. The more recent, the worse it will be for your overall score.
30 percent of the score is based on outstanding debt. How much do you owe on car or home loans? How many credit cards do you have that are at their credit limits? The more cards you have at their limits, the lower your score will be. The rule of thumb is to keep your card balances at 20 percent or less of their limits.
15 percent of the score is based on the length of time you've had credit. The longer you've had established credit, the better it is for your overall credit score. Why? Because more information about your past payment history gives a more accurate prediction of your future actions.
10 percent of the score is based on new credit. Opening new credit accounts will negatively affect your score for a short time. This category also penalizes hard inquiries on your credit in the past year. Hard inquiries are those you've given lenders permission for, as opposed to soft inquiries, which include looking at your own score and have no effect on the score. However, the score interprets several hard inquiries within a short amount of time as one to account for the way people shop around for the best deals on a loan.
10 percent of the score is based on the types of credit you currently have. It will help your score to show that you have had experience with several different kinds of credit accounts, such as revolving credit accounts and installment loans.
Maximizing Your Credit Score
Now that you have a little insight on how credit scoring works, we're going to cover how you can manipulate your credit score in a positive way. There's only so much you can personally control when it comes to improving your credit score in a short period of time. What I'm going to cover should be implemented at least 45 days prior to applying for a loan.
You can't really change your payment history or make your credit accounts older with a better payment history. You also can't remove any of the inquiries you may have had in the last 12 months. However, there is one major factor that can be manipulated and that happens to be the 30% dedicated to "How Much You Owe."
This 30% of your credit score really comes down to the utilization on your revolving credit accounts. In normal words it means the ratio of how much you owe when compared to your credit limit on these revolving accounts. We've found through extensive research as well as client interaction that you can maximize your score by maintaining a balance to limit ratio between 5-10% of your credit limit.
So for example, let's say you have a credit card that has a $500 limit and your balance is $400. From a credit scoring perspective you would have an 80% balance to limit ratio which would negatively affect your credit score. In order to get your balance to limit ratio down to the desired level of 10% or less, you would need to pay the balance down to $50. Our clients have seen as much as a 40 point credit score increase by doing just this!
However, when you make a payment to your credit card company it does not get reported immediately. In fact, most companies have a specific time of month that they report to the credit bureaus and it's important that you find out what date that is. You can get the reporting date by contacting your credit card company and asking them "What day of the month do you typically report to the credit bureaus?"
Once you know the reporting date you can make sure to set a reminder in your smart phone for they day before. The reminder can say something like "log into credit card website to review balance". When you login you look at the balance and if it's above 10% of the credit limit you make a payment online to pay it down. If the balance reporting is less than 5% of the limit, you simply use the card to purchase something that day. This way you'll ensure that the payment will be posted and your balance will be at the desired 10% or less when it gets reported to the credit bureaus.
Since your payment due date and the date the credit card company reports are often two different dates, it may make sense to get in the habit of paying the minimum payment on the due date and then completing the balance manipulation on the reporting date. It's only necessary to do the manipulation when you're trying to finance something as that's the only time you need to maximize your credit score.
For those that don't have the spare cash to manipulate your credit card balances, it's important to realize that the day after the reporting date you can charge the card back up. Most people used their deposited income and checking accounts to pay their utilities and cable bills as well as their cell phones. Did you know that you can pay those bills with a credit card?
This creates an opportunity for you to use the cash bench marked for those bills to manipulate your credit card balances. Then, the day after the reporting date you can charge those bills on the credit cards you just payed on. This way you don't have to come up with extra money to manipulate the credit card balances because all you have to change is how you pay your bills.
How Reward Points Could Be Damaging Your Credit Score
We have a lot of clients that earn reward points by using their credit cards to pay for their normal living expenses and then pay them off when the monthly statement arrives. While this strategy can earn you great rewards, your credit score could suffer even though you are paying the balance off when it is due. The reason for this is your statement due date and the credit card company's credit reporting date are usually different.
So, even though you pay it off responsibly every month, the credit card company could be reporting a high balance to limit ratio making you appear to be a risky borrower. If you happen to pay your bills and living expenses in this way and you're looking to finance something, make sure you find out that reporting date and make your payment 7 days prior. This will allow you to display your true credit score when requesting a loan.
What is Credit Diversification & How it Can Improve Your Score
If you notice on the Credit Factors Graph, 10% of your score is determined by "Other Factors" which mainly come down to the types of credit you have established. There are basically two types of credit and they are revolving credit accounts and installment loans. A revolving credit account is a credit card or some other line of credit with no specific term of repayment. An installment loan is a loan with a specific term for repayment like a mortgage or an auto loan.
When it comes to building a good credit record you will want to have at least one revolving credit account and one installment loan. If you have one without the other you are leaving some valuable credit score points on the table. This problem is easily solved by simply getting the type of financing you don't have.
One of the best ways to do this without getting a bunch of inquiries on your credit report is to find and join a good credit union. Credit Unions have a couple of good things going for them that will help you on this endeavor. First, they offer something called "Share Secure" accounts which we'll get into shortly. Second, they typically only check one credit bureau when retrieving your credit report. This is important because the inquiry will only affect one of your three credit scores whereas a regular bank or lending institution will check and affect all three.
However, there is some criteria that you'd like to be met when choosing a credit union. First, you'll want to know how many credit bureaus they report to. You want them to report to at least two of the three bureaus but preferably all three if possible. Next you'll want to ask what credit bureaus they use when requesting a credit report.You'll want them to use just one bureau when requesting your report.
You can contact multiple credit unions until you find one that meets your criteria. Credit Unions have the best rates on auto loans and personal loans and once you build a relationship with that credit union it becomes easier and easier to conduct business with them.
"Share Secured" Installment Account
This is how a "share secured" account works for installment accounts. You deposit $500 into a "share secured" account and the credit union gives you an installment loan for $500 with an interest rate of 10% and a repayment term of 12 months. You pay $44.19 per month for the next 12 months until the loan is paid off.
At any point that you pay off the loan, you can get your $500 deposit back. This will cost you under $50 in interest and fees and it’s well worth it for the establishment of credit and an increase in credit score.
"Share Secured" Revolving Account
This is how a "shared secured" account works for revolving accounts. You deposit $500 into a "shared secured" account and the credit union gives you a credit card with a $500 credit limit. Anything you charge on that card will accrue interest if it is not paid off when it is due.
You will want to use this card monthly for things like gasoline or whatever you like. However, you will never want to carry a balance higher than 20% of your credit limit because that can lower your score. So if your limit is $500, don’t carry a balance higher than $100 on the card.
We’ve used this strategy to raise a client’s credit score by as much as 60 points in less than 45 days. This allowed her to put an offer in on the house of her dreams before another buyer could beat her to it.
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