Tuesday, August 17, 2010
You're planning on buying a house in a few months and want to do everything possible to raise your credit score before you apply for a mortgage. What are the three most important things you can do today for a higher credit score tomorrow?
That's the question I asked Fair Isaac, the company that created the most popular credit score, the FICO score. And if you're wondering if working toward a higher score is worth the hassle, here's a cut-and-paste from the FICO home page:
A 100 point difference in your FICO score could mean over $40,000 extra in interest payments over the life of a 30 year mortgage on a $300,000 home loan.
So what did Fair Isaac spokesperson Craig Watts suggest? Before making any suggestions, he started with a caveat. There is nothing you can do to change your score overnight. At best, plan on two months, maybe three to see an actual increase — that's why you want to start the polishing process far in advance of any borrowing you intend to do.
Here were his three best tips.
Tip 1: Clean Up Your Credit History
Credit scores are drawn from information in your credit history, so anything that's wrong there will show up here. Go to annualcreditreport.com and pull a free copy of your credit history. Carefully comb through it and check it for mistakes and do what's possible to make it look its best.
Tip 2: Lower Your Utilization Ratio
Visit this page of FICO's website and you can learn all about how credit scores are calculated. One of factors you'll see there is called "Amounts Owed", which comprises about 30% of your credit score. And one of the components of this factor is how much you owe on credit cards vs. your available credit. That's the utilization ratio. As I explained in the video above, you want to keep your utilization ratio below 30%. So if your credit limit is $1,000 on one card, you don't want to owe more than $300 on that card.
Knowing this opens the door to several potential strategies.
You could lower your utilization ratio by paying down your credit cards: that's the ideal scenario.
• If money's tight, then you could at least shuffle your balances between cards. For example, if you've got one card maxed out and two with small balances, move part of the big balance to each of the other two cards so all three show less than a 30% utilization ratio.
• Lower your utilization ratio by raising your credit limits. In other words, if you owe $1,000 on a card with a $1,000 credit limit, raising that credit limit to $3,000 will bring your utilization ratio back down to 30%. A simple call to the bank might be all you need.
Tip 3: Dust Off an Old Card
If you have an account that you've had for ages but haven't used for ages — and is still open — use it. While still technically open, the card company may no longer be reporting the account to the credit bureaus. Using the card will increase the amount of available credit you show — good for your utilization ratio. More important, the length of your credit history makes up 15% of your credit score. So bringing a very old account back to life could help.
But here are two things not to do. Don't open a new account — that definitely will lower your credit score, at least short-term. And don't close any accounts, since that would negatively impact your utilization ratio.
These are the fast ways to improve your credit score — at least if you consider "fast" to be 60 — 90 days. The simplest and best way to improve your credit score, however, is the slowest: paying your bills on time and allowing any negatives like late payments to gradually fade away over time. At 35%, payment history is the biggest component in your credit score.
One Last Tip
While things like late pays and delinquent accounts should drop off your credit history after 7 years (and the older they are the less impact they have on your score) there is a way to have them removed earlier. Simply ask the company that put negative information on your report to remove it. The process isn't hassle-free, but worth considering, especially if you're planning to borrow for a mortgage or other monster loan a few months from now.
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