How to Get a Better Credit Score ASAP
Reader question: "I want to buy a house this year, and I will need to use a mortgage loan for the purchase. I've been told my credit score is a bit low right now, as far as getting approved for a loan. I would like to have a better credit score by the time I'm ready to apply. What things should I be focusing on right now, to make this happen quickly?"
Excellent question. I'm going to give you a short answer to start with, in case you're pressed for time. Then I'll provide some more details and information. Here's the nutshell version.
Short answer: First, make sure you pay all of your bills on time. This is critical, because a single late payment can drop your score by 60 points or more. You should also consider reducing your credit card balances. This will improve your utilization ratio, which can lead to a better credit score over time. Consider keeping your oldest credit accounts open for now. If you close your old accounts, you will shorten the length of your credit history. This could lower your score. Lastly, you should avoid opening any new credit lines unless it's absolutely necessary.
You've probably encountered this advice before, in the course of your research. You'll certainly see it again. And there's a good reason for that. It works! This is a tried-and-true approach to boosting your score. Credit "repair" companies make it seem complicated, because they want your business and your money. But it's not complicated at all.
The Benefits of Good Credit
Having a better credit score will make your home-buying process a lot easier. It will open up some doors for you, as well. Specifically, it helps you in three ways:
- It can help you get approved for a mortgage loan, which is no small feat these days. Lenders today are very strict about the borrowers they'll approve. This is all a result of the housing crisis.
- A better credit score will also help you qualify for a lower interest rate. This could save you thousands of dollars over the life of your loan. Below, I'll show you just how much you might save by securing a lower rate.
- You'll also be reducing the size of your monthly payment, since the interest rate is part of that payment. You'll find an example of this below.
Terminology note: For the rest of this article, you'll see the terms "FICO score" and "credit score" used interchangeably. In both cases, I am referring to your credit score that is produced with the FICO scoring model. This is the number most lenders use when you apply for a mortgage loan. So it's the one you should be concerned with.
Earlier, I mentioned how a better credit score could save you money. Now it's time to look at the numbers to see how this plays out.
Here are two different mortgage scenarios. The borrower in the second scenario has a higher FICO score than the borrower in the first scenario. As a result, his borrowing costs are much less. Take a look...
Mortgage scenario #1
- John uses a 30-year fixed-rate mortgage loan to buy a house.
- He takes out a loan in the amount of $250,000.
- He has an excellent FICO credit score of 805.
- The lender offers him their best interest rate of 5.4 percent.
- This is about the lowest rate for a mortgage at the time he applies.
- John's mortgage payment will be about $1,400 per month.
- The total interest paid over the term of the loan is $255,377.
Mortgage scenario #2
- Sam is also using a 30-year fixed-rate mortgage to buy a home.
- Once again, the loan amount is $250,000.
- Sam barely "squeaks by" with a credit score of 630.
- As a result of his score, the lender assigns a higher rate of 6.9 percent.
- Sam's mortgage payment will be about $1,646 per month.
- Total interest paid over the life of the loan is $342,740.
Sam is paying $246 more per month. Over the life of the loan, he is paying nearly $90,000 more in total interest costs. Why? Because his lower FICO score resulted in a higher interest rate. This affects his monthly payment as well as the total interest paid.
This is a very realistic scenario, by the way. I didn't just pull these numbers out of thin air. This scenario reflects current lending trends and interest rates at the time this article was published. I used a mortgage calculator to determine the monthly payments and total interest charges. And it clearly shows the financial advantages of having a higher score.
How to Earn a Better Score
So we can agree that a better credit score is worth the effort it takes to achieve. The question is, how do you achieve it? How do you repair the damage caused by previous financial problems?
For starters, you need to focus on the things I mentioned above, when I gave you the "short answer" response. You need to pay all of your bills on time. You should consider paying down your credit card balances. You should preserve the length of your credit history. And try to avoid taking on new debt, unless it's absolutely necessary.
The pie chart above shows why these things are important. For example, take a look at the "payment history" piece of the pie. You can see that it weighs more heavily than any other factor. That's why I stress the importance of paying your bills on time. If you're 90 days late on a store credit card, it could drop your FICO score by more than 100 points. That's a huge loss, and it will time to recover from such a decline.
The chart also shows why it's important to limit the amount of credit you use. This is the "amounts owed" slice of the pie. If you have two credit cards, and they're both nearly maxed out, then you have a very high utilization ratio. This raises a red flag with lenders, because it suggests that you're over-relying on credit. It also hurts your FICO score.
It All Starts With You
This will all make more sense if you understand how the credit-reporting industry works. The diagram below shows where your credit scores come from (and why you have more than one). As you can see, it all starts with your financial activity.
When you take out a personal loan ... when you make payments toward a credit card ... when you miss payments ... all of this gets reported to the three credit-reporting agencies. This is the starting point of your credit score. So it all comes from your financial activity, and how well (or how poorly) you repay your debts.
This is the whole point of having a credit score in the first place. Lenders use it to see how well you have borrowed and repaid money in the past. Obviously, this is something they want to know. It helps them measure the risk associated with lending you money.
A better credit score doesn't come easy. You'll have to be disciplined. You'll need to change the habits and behaviors that led to your current situation. You may have to make certain sacrifices along the way. But the ends justify the means.
If you would like to learn more about this topic, I recommend starting with our credit library. This page provides a list of more than 125 articles and resources. You can also use the search tool at the top of this website to search through 1,000+ home-buying articles. Good luck.