The best way to lower your mortgage payments is to refinance. That’s the conventional wisdom when rates are low. By doing so you’ve fulfilled all of your contractual obligations and are simply taking advantage of lower interest rates for a better deal. But the rate you are quoted is directly dependent on your FICO credit score, originated by the Fair Isaac Corporation. Your anticipated pay back ability is rated on a scale from 300-850. The average score in the US is around 690.
A little change can make a big difference when it comes to improving your credit score. Most lenders deal with hard cut off numbers. The difference in rate between a credit score of 697 and 700 can cost you a full third of a point in extra interest. On a $300,000 mortgage that would cost you $22K over its lifetime, the price of a new Toyota Prius.
The first step in improving your score is to learn what it is. Get credit reports from all three major agencies, Experian, Equifax and Trans Union. Rather than pay, you can get a free yearly credit report from AnnualCreditReport.com. Make sure that the information listed on each is accurate. You have the right to dispute anything. You will be asked for proof, such as a police report if you’ve been the victim of identity theft. You are not entitled to a free annual copy of your FICO score, but can purchase a copy of it from Equifax.
The FICO score is determined as follows in order of importance:
- 35% of your rating is based on payment promptness. Paying bills late will really hurt you here. If you have an option of paying a credit card off in full a few days late or making a minimum payment on time, choose the latter. You can always pay off the balance the next billing cycle. The length of your delinquency is a factor as well. Bankruptcies, judgments and liens are counted here. On-line banking is a good way to handle the bill juggle. Many banks now offer the service for free as a way to cut their check processing costs. Simply set up your payees on line, and then enter the payment dates with your bank. The bank will handle the rest, saving you postage as well. Since the funds aren’t debited until the day you choose, you can stretch the use of your cash while insuring that your payments are made on time.
- 30% of your FICO is based on how much credit you use. If your credit lines are maxed out your score will plummet. Some well meaning people try to get on top of their debt by canceling credit cards. This is one of the worst things to do because your credit line will drop while the percentage of utilized credit will soar. Keep the cards open, even if you are charged reasonable annual fees. The fastest way to improve your score is to pay your credit card balances down. Consider this: If you are carrying a debt of $5,000 at 12% and you have $5,000 in savings, earning a rate comparable to the so called high yield savings account at American Express, 2% , you are losing 10% on your money each year! If you can’t pay your cards off, spread around the balances so that the percentage of utilization drops on each loan. If you can get a single new low interest high balance credit line or card with little effort, do so, but don’t tap it except to transfer a balance. Be aware that most new cards start with teaser rates. Make sure you remember when that introductory interest rate will go up. Another strategy is to time your payments not only before your lenders’ due dates, but prior to the dates on which your loan companies reports to the credit agencies. You’ll find that information on your credit reports. By paying then, a lower debt will be reported.
- 15% of your score is based on the length of your credit history, the longer the better. In today’s climate those who can demonstrate timely repayments extending longer than 10 years have a leg up over those with clean credit dating back less than a decade. Since bankruptcies don’t show after ten years, a flawless record that begins simultaneously exactly 10 years before is a red flag to lenders. If you decide to close credits cards to avoid excessive annual fees, it’s a good idea to keep your oldest cards open to prove long term credit worthiness.
- 10% of your score is determined by the nature of the credit utilized. Is it unsecured, or did you take on a longer term debt to pay off a big ticket item like a car? If the vast majority of your debt is on a first mortgage or student loan, that fact counts for more than if you have the same amount extended over credit cards.
- The last 10% of your rating is based on recent credit inquiries or newly established credit. If you have several new inquiries, your score will decline because the activity on your part is thought to show that cash is tight. Shop carefully before you allow an inquiry, then authorize all of them within a narrow time frame. If they are done within a couple of days, the FICO scoring algorithm will recognize that you’re shopping for a single loan and not multiple ones.