Since mortgage interest rates have been low for several years, many home buyers are under the misconception that their credit score won’t make that much difference in the amount they pay over the life of the loan. In reality, even a point or two difference in the interest rate can easily amount to $50,000 to $100,000 over the term of the average 30-year home loan. A lower interest rate may also result in lower monthly payments, which can leave extra cash in your pocket. The secret to qualifying for the best interest rate on your mortgage is to start whipping your credit score and history into shape at least a year before applying for your loan. The following steps will help you improve your financial picture so that you can face your mortgage lender with confidence.
What Is a Good Credit Score? Credit scores range anywhere from 300 to 850. Your score is calculated using a combination of factors, including the length of credit history, past payment history, type of credit, and amounts owed in relation to available credit. As a general rule, individuals with credit scores 740 and above are in a position to qualify for the best loan rates. You may still qualify for a mortgage even if your score is below 740; however, you will likely pay one to two points more in interest.
Get Your Credit Report: It is important to review your credit report at least once a year, so you will have a clear picture of where you stand. Be sure to dispute any inaccuracies that you may find with the credit bureaus.
Lower Your Debit-to-Income Ratio: Your debit-to-income ratio is the amount of debt your lender believes your income will support. It is recommended that you keep housing payments at no more than 28 percent of your monthly income. You should strive to keep the total of all your debt to less than 36 percent of your income. You can lower your debt-to-income ratio by eliminating any low-balance loans that are close to being paid off and reducing your outstanding credit card debt.
Get Rid of “Toxic” Accounts: In-store financing and rent-to-own accounts have horrendous interest rates, high payments, and have a bigger impact on your credit score than other types of debt. It is best to pay off and close these accounts as quickly as possible.
Pay on Time: Almost everyone has had a few late payments here or there. You can lessen the effect of past payment problems by ensuring that you have at least six to 12 months of consistent on-time payments before applying for a mortgage.
Lower the Amount of Credit You Utilize: You should try to keep credit card balances to less than 20 percent of the total credit line. You should also avoid closing credit cards as you pay them off unless they are store cards or have an annual fee. Closing the accounts will lower your amount of available credit and actually increase your debt-to-income ratio.
Avoid Applying for New Debt: Opening up a lot of new credit lines at once can lower your credit score. Each time you apply for credit, the lender places a hard inquiry on your credit, which has an adverse effect on your overall score. An influx of new accounts also raises a red flag for lenders that you are about to become overextended.
It can be frustrating to have to delay your home search in order to work on your credit; however, a little patience and diligence can earn you thousands of dollars in savings.
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