Do you know what goes into a credit score? We're going to be going through a five-part series to share with you what you need to know.
What makes a credit score?
Let's start off with the five factors that can ultimately affect your score: payment history amounts owed, length of history, credit mix, and credit inquiries for new credit. The first three go hand in hand. Your payment history will appear in your credit report for all of your open and active trade lines. Payment history demonstrates how you were able to manage your debt over a period of time. Paying your bills on time consistently yields a higher credit score, and in turn, allows you to borrow more money.
Additionally, the longer your history of consistency exists, the higher your score will be. I mean, this is important, because while you're shopping for a home, do not close any accounts as that cuts your history short. Also, keep your balances low, ideally below 30% of the credit limits and make sure above all else, keep making your payments on time. I mean, if you're looking to purchase a home, now is not the time to miss a payment. Even if it's by accident, a missed payment can drop your score by as much as a hundred points.
Credit Type Inquiries
As we're talking about credit, many people don't realize the types of credit you can have affects your score. I mean, did you know that people with student loans can sometimes have the very best credit scores? Creditors are looking for a good mix of revolving credit, installment debt, lines of credit, and mortgage history, but don't worry if you're a first-time homebuyer having several credit cards, a student loan, and even a car loan is a great mix. Just keep those payments low. So your debt to income ratio is strong.
Inquiries also affect your credit report. I mean, think about it this way, a creditor's going to look at your attempts to get additional lines of credit with concern. If you're continually applying for credit cards, cars, or other debt, and don't have new trade lines to show for it, it will count against you. It can also count against you if you've applied for a lot of credit in a short period of time, that's why, although credit inquires fall off over time, they can leave a stain on your credit if too many of them exist.
So we're talking about credit score optimization, and I want to ask, have you heard the term credit utilization? It simply means the ratio between your credit line limit and your current loan balance. Keeping your current balances on your open accounts below 30% of the limits is key for keeping a healthy score, and especially allows you to take advantage of some of these new market opportunities, like first-time homebuyer purchase programs, or buying your first investment property, a tip to get your credit utilization down without having to pay any money out of pocket is to request a credit line increase. If you've had a card for over six months with a good payment history, you may be able to get a credit line increase, which improves your overall credit profile.
Opening a new account can also improve your credit utilization. Now, be aware that new accounts are just that, they're new, and any new activity on your credit report, no matter how high the credit limit can be viewed as a negative action and cause your score to temporarily decrease before it goes back up longterm. So don't do this right before applying for a mortgage.
Paying Down Debt
If you're like most Americans, you probably have credit card debt that's keeping your credit score low. If you're looking to purchase a home, coming up with a pay-down strategy is key to your success. I mean, you can focus on the credit utilization method we talked about in our last video, or you can even keep it simpler by focusing on paying off debt with higher interest rates first. Those higher interest rate cards are building up higher balances every single day with the added interest. Then as you pay off each one of those cards, you can use what's called the debt snowball system, where, as you pay off debts, you apply that same amount plus what you were already paying towards that singular debt, as in the minimum payments, towards the next credit card or loan. You keep doing this, paying off each credit card in full, and then applying that entire amount to the next one until finally you get them all paid off.
And while being completely debt-free feels great, it is not our requirement to own a home, nor is it an impediment to homeownership. Often you can begin creating wealth while paying down your debt.
Become an Authorized User to Improve Your Score
As we wrap up our series on credit scoring, I want to talk about one of the quickest ways to increase your credit score. And that's by becoming an authorized user on a family member's credit card, being an authorized user, you will get all of their histories. So make sure that you know that they have an established on-time payment history with the specific credit account that you're going to co-sign on. Credit cards with a longer open history pack a bigger punch because they show responsibility over time. This is particularly helpful if you're a parent, and you're wanting to help set up your child for success. I added all three of my kids to my accounts when they were 16 years old to help them build their credit. Then when they were 18, they were quickly approved for their own credit card. This way by that they were ready to purchase a home at 20, they had a credit score of over 740. I mean, that's a game-changer.
If you've enjoyed this series, I'd love to share more and set up a plan that's just right for you, based on the goals that you have for homeownership.
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