One of the most surprising lessons I learned when buying my first home was the crucial role of my credit score. Alongside needing cash for closing costs, my credit score played a significant part in securing my FHA loan. In this article, I will share five effective strategies to improve your credit score before buying your next home.
What is a credit score?
First, it’s important to know, just what exactly is your credit score? Your credit score is a calculation that is determined, primarily by three agencies, that assesses your ability to pay back debt. Now, depending who you are, this can sound scary. So many people were taught to believe that debt is bad. But, I believe, when handled properly, debt can actually be the best way for you to improve your life and your wealth, bar none. Therefore, when used properly, debt can change your life for the better, and can do so potentially for generations to come! Each company determines your number based off their own systems, weight, and number scale, AND each company is OBLIGATED to provide you with your credit report for free, once a year. (Do not be confused – this is MUCH more detailed than just the scores you see on your bank apps or credit card apps.) In general, your credit score is compiled from the following categories: payment history, amounts owed, length of credit history, new credit and mix of credit. Here are ways to improve each category!
1. Payment History
This one is pretty straight forward, and unfortunately, there is no shortcut to improving your history – it is exactly that – HISTORY. So, therefore, the longer you show that you can pay AT LEAST the minimum due by the date that it is due, the more your score improves. If you have never had a credit card, then you will need to get one to start building. That said, your credit score is only supposed to go back seven years, so, if you did some damage seven years ago, and you lived somewhere else (maybe there was an angry ex?) once you request your credit report – check to make sure that the address associated with those bad choices are no longer appearing and effecting your score. You shouldn’t have to suffer for the rest of your life! If you find them, research ways to write the letters to remove those addresses from your file, and then, consequently, those bad history marks.
2. Amounts Owed
Now the important number here is not to show the enormous amount of money you spent within a month – it’s not a contest! Rather, the number they are really concerned with is how much money did you spend versus how much money were you ABLE to spend? Let me explain – let’s say that you get a credit card for $5,000. Great! You love the points that the card gives, like this one! While they aren’t paying me to write this article, I will get a referral bonus of points, if you happen to use my link! Points are amazing and I will link another article here all about that for travel. Yet, I digress. So you have the ABILITY to spend $5,000. Credit card companies would LOVE for you to spend it! Especially if you can’t pay it off in one month. Then, you would have to pay them interest on the balance. This is where credit cards are dangerous. Never spend more than you can pay off immediately. The credit score companies, however, know this and do NOT want you to spend that $5,000. Instead, they want you to spend, ideally, under 10%, so $500 for this scenario. Although, I will tell you, spending under 5% is even better, and gets you a higher score faster.
At this point, you may be thinking – but Eric, I read your article about points, and I want to play! How can I do that if my balance is so low – only $500 will take FOREVER to accrue points! Or, you are thinking, if my real budget is so low, then why even bother? Well, there are two answers to both questions. Firstly, the $500 is only what they want to see REPORTED to them. Remember my problem from before? I would pay off my bills as I spent, resulting in it often looking like I wasn’t spending any money at all! SO – the work around is to look at your credit card statement and see WHEN was that statement actually generated. This is when the credit card companies report the amount of debt accrued. If you happen to pay off that amount so that ONLY $500 or less shows before that date, then, the credit reporting agencies are none the wiser, and your score goes up! Secondly, this is an important game to play because, remember, the higher your credit score, the better your interest rates will be on any loans! By the way, bonus tip at the end.
3. Length of Credit History
So, like number one, there is no short-term fix for this one. That said, if you are not regularly using a credit card, DO NOT CANCEL it unless they are charging a fee for no benefits. There are plenty of cards that have no fees associated with them, quite often by the same companies providing them. So, if you are no longer using a card, call them up and ask if they have a no fee version to their card and request to downgrade the card to that one. Again, as long as you are not using the benefits. Also, with this knowledge, if you need a quick boost to your number because of an upcoming loan, perhaps you might have a parent or trusted family member with good history, that also has a card they’ve had for a long time. If they would be willing to add you as an authorized user, that credit card history, spending limit and credit line will be added to yours and within 30 days, you will see a boost! (Be sure the person you are doing this with actually has a good history because it could work against you if they don’t)! Also, knowing this information, find out from you credit cards when they would be willing to add children as authorized users – then they can begin building their credit history as well! (Just make sure to make good choices on that card so you don’t mess them up!)
4. New Credit
With this category, they are looking to see how often you are opening new credit lines. So, getting 10 new credit cards at one time looks really bad. Don’t do it. Take your time. If you know you are going to need a car loan or getting a mortgage, don’t go opening up 5 new credit cards just to get 10% off or whatever at the department stores. (Incidentally, just so you know, department stores will typically not give as high credit limits as regular banks).
5. Mix of Credit
Again, here is the dangerous part of credit. The credit score companies WANT you to have debt. In fact, they WANT you to have lots of debt, so you can get better rates to get MORE debt. So, if you have a car loan, credit cards and a mortgage, you will have a better score, provided you adhere to all the above. The good news? This factor plays the LEAST amount in effect of your score, so if you don’t NEED these loans, don’t do it! (Only do credit cards though ’cause points are awesome when using them responsibly)!
Conclusion
Managing debt wisely is key to building a strong credit score and acquiring wealth through real estate. By following the tips outlined in this article, you can boost your credit score and secure better loan rates. Remember, if paying off your credit card balance before the statement date isn’t always possible, consider using multiple credit cards to manage your utilization ratio effectively. Start implementing these strategies today to pave the way for a successful home purchase! And, now for that bonus tip: if paying off your credit card before the statement date isn’t always possible, another way to increase your 5% spending power is quite simple – have multiple credit cards! The more credit limits you have available to you will increase the amount of the 5% ratio that is factored into your credit score. Just try not to max out any card when playing with the ratio, and be careful not to spread yourself to thin. Remember – just because you have the cards does not mean you have to use them consistently.
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