You’ve taken down the Christmas tree and swept away the last remaining strands of New Year’s confetti. Now it’s time to roll up your sleeves and start making good on those personal finance resolutions. Remember them? You know: Raising your credit score, obtaining a refinance or buying a new home. Some economists predict mortgage rates will head up this year as the economy gets stronger, so now is a good time to check your credit score and figure out whether there are any errors, or if there is a need to improve the score to stay on track with your house financing goals.
What’s In Your Credit Score?
Credit scores are used by lenders to determine your credit risk; the number can influence the kind of interest rates available to you. Most credit scores are based on the FICO scoring model. You should realize that each credit bureau and each mortgage lender has its own tweak introduced into the model to emphasize certain characteristics, but that – for the most part – the base model is the FICO formula.
Here is a basic breakdown, according to myFICO.com, of what is used to determine your credit score:
- Payment History (35%): Whether you make your payments on time. Includes public records of negative items, including collections, bankruptcy, liens, etc.
- Amount of Debt (30%): This includes the amount of credit you are using, out of your available credit. It also includes how much you still owe on installment loans.
- Length of Credit History (15%): How long you have had credit, and how long you have had open accounts. Also includes your recent account activity.
- New Credit (10%): Number of hard credit inquiries indicating that you are looking for new credit, and the number of credit accounts opened recently.
- Types of Credit (10%): Different types of loans you receive, including credit cards, payday loans, auto loans, mortgages, student loans and other types of credit. Note that some types of credit are more “desirable” than others.
As you can see, different items affect your credit score more than others. When focusing on trying to improve your credit score to present yourself as a lower risk to mortgage lenders, it is a good idea to focus on the areas of most impact.
Improving Your Credit Score
Before you buy a home, check your credit score. For example, the FICO score, which is one of the most frequently used credit score systems, ranges from 300 to 850 and most people score in the 600s and 700s. The New York Times notes that it’s hard to come up with a baseline for a loan because of the different factors involved, such as lending terms and down payment amount, but that better rates these days are generally available with a credit score of at least 740.
You can get a general idea of where you stand by purchasing a score package from one of the credit bureaus (or myFICO), or by obtaining versions through several companies that collect the information. Realize, though, that what you see may be a little different from the exact result that a mortgage lender will see when you go to buy a house. You also are entitled to a free copy of each of your credit report from each of the three major credit reporting agencies (Experian, Equifax and TransUnion) every year, which can be helpful in pinpointing credit score errors and other trouble spots. (FYI, a credit report shows your credit history vs. a credit score, which is a number.)
For the most part, the best way to improve your credit score is to make your payments on time, and pay down your debt. If you can decrease the amount of available credit you have used up, while showing financial responsibility in making on-time payments, you will be more likely to improve your score a little faster. At the same time, you can prevent your score from falling by keeping long-standing credit card accounts open and active (pay off charges you make with the card) and by avoiding opening new credit accounts.
It may take between 30 and 90 days to see improvement in your score – and it could take even longer to make big changes, especially if you have a foreclosure or other “big” negative item in your credit history. However, if you work hard to improve your credit score, chances are that you can improve it enough to get approved to buy a home or refinance.
Share below where you want your credit score to be in 2011:
Photo: Casey Serin, Creative Commons 2.0
Miranda Marquit is a journalistically trained freelance writer and professional blogger. She contributes to several personal finance web sites, writing on topics such as budgeting, home loans and mortgages, and investing.
