How to Improve Your Credit Rating

Reader Question: I plan to buy a home next year, and I've been told I need to have a good credit rating in order to get a mortgage loan. What exactly does this mean, and how do I improve my credit rating if it's low?

This is a question a lot of people are going to be asking in 2009, in my opinion. I'll explain why in a moment, but let's start with some terminology.

When you hear the term credit rating it usually refers to a person's credit score. This is a numerical number (usually between 300 and 850) that is based on information within your credit reports. There are three different companies that maintain this information on U.S. consumers -- TransUnion, Experian and Equifax. These companies generate credit reports, which are then converted into scores.

So when you hear somebody say they need to improve their credit rating to get a loan, they are talking about improving their credit scores. It's just a different way of saying the same thing.

Why Your Credit Rating is Important

When you apply for a mortgage loan, the lender will review all aspects of your financial background. This includes your income, the amount of debt you have, and your credit rating and history. This gives them some idea of how well you have managed your finances in the past. Obviously, a lender needs to know your credit rating and related information, because it helps them assess the level of risk involved with giving you a loan.

If you have a good credit rating (a higher score), then there's a good chance you'll be approved for the loan. You also have a better chance of getting a low interest rate on the loan, which equates to a smaller mortgage payment each month.

On the other hand, if you have a bad credit rating (a lower score), then you will have trouble getting approved for a mortgage loan. And if you do get approved, you'll end up paying a much higher interest rate -- which means a bigger mortgage payment.

This is why your credit rating is so important if you plan to buy a home in the near future. It's also why so many people are trying to improve their credit ratings these days. Because of the economic crisis we are experiencing right now, lenders are really strict about qualifying borrowers. So if you want to get financing in the "new economy," you actually need a better credit rating than what you needed a couple of years ago.

That's what I meant when I said that a lot of people would need to improve their credit rating in 2009. The question is ... where do you start? Here are some tips.

How to Improve Your Rating

There are a lot of things you can do to elevate your credit score. Basically, anything you can do to be financially responsible will help you improve your rating. This includes paying all of your bills on time, reducing certain types of debt (such as credit cards), and correcting errors on your credit report.

We have a bunch of articles on the main website that will help you improve your credit rating before applying for a mortgage loan. I recommend starting with these:

• Credit Repair 101 - What Home Buyers Should Know
• How to Improve Your Credit Score

I hope this answers your question, and wish you all the best in your home buyer experience.