Improving Your Credit Score From my experience working with many potential home buyers looking to improve their credit, they are frustrated! They are frustrated because they receive conflicting information and most places try to teach you everything about credit instead of helping them improve their credit. I know what you want you want to IMPROVE your credit so LET S GET STARTED! STEP 1: Pay Everything NEARLY On Time Did you know that late payments are not reported on your credit until you are 30 days or more past due on your payments? That means that as long as you pay your debt payment 29 days after it is due or sooner it will probably not get reported as a late payment. Of course, paying 29 days late is not recommended. Your payment history accounts for the largest portion of your credit score. 35% of your score is based on how well you have made payments in your past which also means making on time payments from here forward will be the easiest, and quickest way to improve your credit score. STEP 2: Reduce OR REORGANIZE How Much You Owe Most people have heard that your debt to income ratio will impact your credit score but this is not exactly right your balance to limit ratio is what does impact your score. So what does this mean? If you take all your combined revolving (credit cards) balances and compare those to your total revolving credit limits you can get this ratio. Reduce or reorganize your balance to limit ratios as close to, or under, 30% on each of your accounts. Here is an example: Credit Card #1 Balance $2,500 Limit $5,000 Credit Card #2 Balance $2,000 Limit $2,000 Credit Card #3 Balance $0 Limit $4,250 TOTAL CREDIT CARDS BALANCES $4,500 LIMITS $11,250 Credit Card #1 balance to limit ratio = $2,500/$5,000 = 50% Credit Card #2 balance to credit ratio = $2,000/$2,000 = 100% Credit Card #3 balance to limit ratio = $0/$3,000 = 0% TOTAL BALANCE TO LIMIT RATIO = $4,500/$11,250 = 40%
The goal is to get to as close, or under, 30% balance to limit ratio on all of the accounts. With #1 at 50%, #2 at 100%, #3 at 0% and combined at 40% we have some work to do. Let s look at some solutions: OPTION A: Pay down your balances to as close to 30% of the limit as possible. #1 NEW Balance $1,500 #2 NEW Balance $600 #3 NEW Balance $0 (no change) TOTAL NEW TOTAL BALANCE $2,100 REQUIRED CASH FOR OPTION A EXAMPLE = $2,400 This option will get you to the ideal ratio of 30%, which will likely improve your score greatly due to the reduction from 50% on Card #1 and 100% on Card #2 and keeping Card #3 at 0%. OPTION B: Reorganize your balances to as close to 30% of limit as possible. #1 NEW Balance $2,000 #2 NEW Balance $800 #3 NEW Balance $1,700 TOTAL NEW TOTAL BALANCE $4,500 REQUIRED CASH FOR OPTON B EXAMPLE = $0 This option will not get you to the ideal ratio but will reduce your ratios on Cards #1 & #2 while transferring your balances to Card #3 while still staying as close to 30% as possible. OPTION C: Increase limits on revolving accounts to get your balance to limit ratio as close to 30% as possible. #1 NEW Limit $8,333 #2 NEW Limit $6,667 #3 NEW Limit $4,250 (no change) TOTAL NEW TOTAL LIMITS $19,250 REQUIRED CASH FOR OPTION C EXAMPLE = $0 This option requires no cash but does require the cooperation of your credit card companies to increase your limits. By doing this you can get to the 30% balance to limit ratio very easily and very quickly. OPTION D: ALL OF THE ABOVE Reorganize and Increase Limits (decrease balances if you can not increase limits high enough) #1 NEW Balance $2,000 NEW Limit $6,667 #2 NEW Balance $800 NEW Limit $2,667 #3 NEW Balance $1,700 NEW Limit $5,667 TOTAL NEW TOTAL BALANCES $4,500 NEW TOTAL LIMIT $15,001 REQUIRED CASH FOR OPTION D EXAMPLE = $0
Use these examples as SUGGESTIONS and get creative using the methods shown above to modify your credit card debt to a balance to limit ratio as close to 30% or less. STEP 3: Do NOT Open or Close Your Accounts The third most important factor in your credit score is the length of time your accounts have been open. Do not open or close any accounts and you can manage this part of your score very easily. Oops...did you just open or close an account? Don t fret you ll be ok. Only 15% of your credit score is driven on the length of your accounts and one new account (as long as it isn t your only account) added or closed should hardly impact your score. The key to remember on this is to keep your accounts open as long as possible with activity. Most companies who see no activity for an extended period of time will close your account. To avoid this from happening, charge something every 3 months or so and pay it off when the bill comes in the mail. If you do this, your account will stay active, with good payment history and you wont have to pay any interest. STEP 4: Do NOT Pay Your Collections I bet your are thinking Great! I don t have to pay off my collections to IMPROVE my score. Well, not quite let s look at this closer. Paying off old collection accounts will have a negative impact on your credit score. Collection accounts can t be good, right? Right collection accounts are not good. So what should you do? If you are NOT looking to qualify for a mortgage or new debt any time soon get those collection accounts paid and start getting some time under your belt to see an improvement in your score over time. When paying off collection accounts here are some good tips: When calling to pay your collections call on a FRIDAY people are just happier on Friday s and are more willing to help (aren t you happier on Fridays?) Always request a settlement on your debt collection agencies typically buy the bad debts for pennies on the dollar and are likely willing to accept less than the original debt (Hey, they will still be making some profit!) GET PROOF This can not be stressed enough. Once you pay a collection agency get a letter, on letterhead stating the Account is PAID IN FULL referencing your account number and your name. If you ARE looking to qualify for a mortgage or new debt soon there is some additional info to understand. Depending upon your situation you may have a credit score high enough to qualify without paying off your collections and letting time go by. Talk with your
lender and they should be able to tell you if your score is good enough. If it isn t you will have to follow the guidelines above and let some time go by. If your score is good enough here is what you should do: 1. Determine if your collections will need to be paid as a condition of your loan approval a. If not, don t worry about paying them off until after closing and then follow the instructions above b. If so, keep going 2. Arrange to pay the collection accounts off at the time of closing a. Most lenders will allow you, and prefer you pay off collections at the time of closing as part of your total cash required at closing b. The mortgage company can work to get payoff amounts from the collection agencies c. The mortgage company will also work with the title company to have checks payable to those collection agencies available at closing i. All you will have to do is mail the check after closing What s the deal with collections and why can t I pay them off? Here s why Let s say you ordered a few pizzas back in college, 8 years ago (maybe more for some of us). You wrote a check and it bounced. You never came clean on that payment and eventually the pizza joint sent the debt to a collection agency. You didn t care much about that debt and totally forgot about it after a while. Now you are ready to buy a home and the lender pulls your credit. That $10 pizza bill is now $48 with penalties and is with ABC Debt Collectors. Your score is high enough to qualify but the lender is requiring you to pay off the collection. Here is what would happen if you paid off the debt: CURRENT CREDIT SITUATION: 8 year old collection account that has NO ACTIVITY for 7 years Collection is viewed as a derogatory, or negative, account on your credit bringing your score down (only down a little since it is so old) CREDIT SITUATION, IF COLLECTION IS PAID: 8 year old collection account that has CURRENT MONTH ACTIVITY Collection account is viewed as a derogatory account on your credit The difference? The action of paying off the collection updates the credit report to think you have recent activity on a negative account, therefore reducing your score as if you just had a new collection account opened. STEP 5: It Hurts Inquiries Hurt Me! If you are reading this to improve your score so you can qualify for a mortgage you probably have bigger concerns than whether or not inquiries will hurt your score. I know that is harsh, but I would rather be honest and up front with you than to tell you that
you should be worried about inquiries when you might have late payments or collection accounts on your credit. In the scheme of things, inquires will hardly impact your credit score. Focus on the steps above, then understand how inquires can impact your score and when to worry about it. Only hard, voluntary, inquires can negatively impact your credit score. In other words, only those inquiries YOU AUTHORIZE to obtain new debt will impact your score. Even then the impact is minimal. If you are looking to shop around for a new debt (a car for example) you are provided a time period to allow multiple lenders to pull your credit without numerous inquiry hits on your credit. Typically the time frame is considered 30 days, but it s recommended that you stay within 15 days because some can impact you from day 16+. With that being said, multiple inquires will not impact you if you are shopping for the same kind of debt. This means if you are shopping for a car loan at the same time you are shopping for a mortgage, homeowners insurance and a furniture store credit card you will get hit with an inquiry for each type of service (in this example 4 inquiries). When multiple inquiries from different industries hit your credit this can drastically impact your credit. If you shop within 15 days for one service the impact to your score will likely be 7 points or less. Step 6: Do NOT Hire a Credit Counselor Hiring a credit counselor can impact your ability to qualify for a loan for as long as two years. Carefully consider whether you need the assistance of a credit counseling service before utilizing their services. When qualifying for a mortgage consumer credit counseling services are viewed as badly as a bankruptcy is and will require two years to pass from the date you sign up (with good payment history) to be able to qualify for a mortgage. Understand what credit counseling does and do it yourself for FREE: Evaluate your budget and look for opportunities to save on discretionary spending Evaluate your debts and which ones impact you the most o Calculate your payment to balance ratio (payment divided by balance) this will show you where you can make the biggest impact to how much you pay each month
o Determine which debts have the highest interest rates paying off the highest interest rate debts first will allow you to pay things off as quickly as possible Contact your creditors and explain you are trying to find better ways to manage your money and your debts and you would like to work out a payment arrangement with them o Some may work with you while others may not be patient and realize they are not required to do anything to assist you o Ask for reduced payments without late payment being reported o Ask for reduced interest rates Create a plan that you can stick with and stick with it! Step 7: Work with a KNOWLEDGEABLE Mortgage Lender Coming from a self proclaimed knowledgeable mortgage lender what else would you expect? Even if you are working with another mortgage lender and just using this report to put yourself into a better position before buying a home and qualifying for a mortgage, choosing a knowledgeable mortgage lender can make a HUGE difference. Mortgage lenders are your gateway to obtaining money for your home purchase but they can also be your advocate and consultant. Some mortgage lenders take the time to understand what options are available to best assist their customers. A good, knowledgeable mortgage lender can: Offer guidance and suggestions for ways to improve your credit Give you access to credit reporting agency tools for credit improvement (next step) Tell you the minimum number of steps you need to do to position yourself for qualifying for a mortgage at the best rate and terms Provide you a plan before and after closing to improve your credit to the best it can be Avoid pitfalls you wouldn t otherwise know about (see Step 4) Be your gateway to down payment assistance and other money saving opportunities (sometime thousands of dollars) Consider choosing the RIGHT LENDER before choosing the right rate. If you have the right rate on your mortgage but the wrong lender that could cost you more in the long run than the right lender at a slightly higher rate. A higher rate with a better loan option can save you thousands more. Choose the right lender do your research, ask questions and get a referral.
Step 8: Use Credit Reporting Agency Tools Once a mortgage lender has pulled your credit report there are certain tools that can assist you in improving your credit without having to figure it all out yourself. The mortgage lender pulls a credit report through a credit reporting agency which compiles all the data provided by the three major credit bureaus (Equifax, Experian and TransUnion). The credit reporting agencies have worked to create tools for lenders to use with their customers and here are a few that are most popular: Potential Score Increase o Immediately after running the report the lender can see your potential score increase What If o This tool provides the lender the opportunity to run what if scenarios to see how the score would be impacted if certain actions were taken
o For example, if you wanted to pay down your credit card to a 30% balance to limit ratio but wanted to see the impact to your score before doing so, your lender could run this what if and see the expected change to your score before doing anything! Analyzer o Unlike the What If, this tool will tell you what you should do. o Just enter the funds you have available to use to improve your credit (or just enter some large dollar amount, say $5,000 as an example) and it will use the least amount of money to show you how to improve your score as high as it can go.
NOW GET GOING! About Lending A Hand Scott Wynn and Marla Wynn make up The Wynn Team and are the authors of Lending A Hand. Scott and Marla are a husband wife Colorado mortgage team who s day job consists of helping people achieve the American dream of owning a home through mortgage financing. Through our experience in the mortgage business and closing over 1,000 mortgage loans (over $200 million in mortgage volume), we realize the mortgage business is a mystery to most. Many loan officers stick to the knowledge is power saying by attempting to maintain the mystery. We, too, agree that knowledge is power which is why we are passing our knowledge along to you. Our hope is that you can use the information we provide on this site to increase your power when obtaining your own mortgage. Our blog is intended to be interactive, providing you with many methods to reach us in the case you need assistance with a mortgage loan (we lend in Colorado & California) or if you just need a little information or advice. So feel free to email us, comment on a post or call us. Lending A Hand, Scott and Marla Wynn