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Buying a New Home? Improve Your Credit First

Financial institutions often use a credit score to predict the risk of lending money to an individual. They believe the higher your credit score the more likely you are to pay back the loan. On the other hand, they believe the lower your credit score the less likely you are to pay back the loan. This measure of risk determines if a lender will make a loan available to you, and it can also impact the terms of the loan. From a practical point of view, the better your credit score the lower the interest rates will be offered when you apply for credit, especially for a home mortgage. For this reason, if you are considering buying a new home, it’s important to understand your credit and how to improve it. Minor changes in your credit could be the difference between affording a new home or not, or how big of a home you can afford.

 

These days most lending institutions use the FICO score to measure consumer lending risk. The FICO score was a model developed by the Fair, Isaac Company to predict risk. It takes into account your payment history, the amount you owe, the length of your credit history, number of credit inquiries, open accounts, information from public records such as liens, bankruptcies, etc. The FICO score is a number between 300 and 850, although most people fall between 600 and 750. The higher this number, the better your credit, and the lower your interest might be when you apply for credit.

 

The first step in understanding your credit is reviewing your credit report. A credit report can be obtained from any of the three credit reporting companies: Equifax, TransUnion or Experian. The report will show your personal information, credit history, inquiries made and public records. Once you review your credit report, ensure all information is accurate. In case of errors, contact the credit agency immediately and have the error corrected. Assuming all the information on your credit report is accurate and your FICO score is still low, there are a few ways of improving it.

 

More than half of your credit score come from your payment history and the amounts you owe. Late payments can significantly lower your credit score. If there is one action that you absolutely should take is to make payments on time. Many people who make late payments do so simply because they forget. If you use an electronic calendar, you can set up reminders for the whole year for at least 10 days before your bills are due. You can also sign up for automatic email reminders from your creditors. You may even be able to automatically charge your bills to your debit or credit cards. If you are having problems affording making payments, you should try to negotiate a payment plan with your creditor. Avoid ignoring the problem by not making payments. Over time, a record of on time payments will increase your score.

 

You should also minimize the amount you owe by paying off debt. You should aim to owe only a small percentage of your total available credit. For example, if you owe $1,000 but you only have a credit limit of $2,000, you owe 50% of your available credit. On the other hand, if you owe the same $1,000 but your credit limit is $5,000, you only owe 20% of your available credit. This latter situation is better.

 

Another significant part of your credit score is the number of open accounts and the length of your credit history. You should always avoid opening unnecessary accounts, unless you are still trying to create a history. A large number of open accounts could impact your credit score negatively. You shouldn’t necessarily close accounts. Closing accounts will reduce your total available credit, which then will increase the percentage of your debt to credit. You can keep accounts opens, even with a zero balance. This will remain your available credit high and show a lengthy history, both beneficial to your score. Just avoid opening new unnecessary accounts.

Many credit inquiries during small periods of time can also reduce your credit score. This doesn’t mean that you shouldn’t shop around for a loan. Many inquiries of the same type, for example from several mortgage companies within a short time period, will be recognized by the model and should not impact your credit negatively. Also, checking your own credit should not impact your score. But, if you have credit denied, you can wait some time before applying for another account.

 

All these simple steps should help you improve your credit score, which will put you in a path to home ownership faster than you think. If you are having financial difficulties, or for more in depth financial and credit advice, consider consulting a financial advisor.

 

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  • Last edited November 30 2008
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