Positioning yourself to get the best mortgage rate possible can pay huge returns over the life of a loan. Market fluctuation and interest rate changes are mostly out of your control, however, it is within your control to be what the lenders consider a good credit risk. The main factors that influence how the banks view you as a borrower are credit score, debt to income ratio, and savings or assets.
Credit scores are determined by a very complicated set of algorithms that ultimately spit out a number between 300 and 850. This is called your FICO score and the higher the number is the better of a credit risk you are from the lenders perspective. There are three different credit bureaus Equifax, Experian, and Transunion. Most lenders will pull reports from all three bureaus and then ‘throw out’ your highest score and lowest scores – leaving them with the ‘mid-score’ – although some lenders will just use your highest score.
All of the bureaus have their own system for calculating credit risk, and it can be very complicated. It’s not a perfect science but there are a few things that you can do to help raise your score.
- Make sure that all of your credit card balances are at 30% or less of the credit limit. If you only have one credit card and it has a high balance, as compared to the credit limit, then it might make sense to open a new credit card line or two and transfer some of the balances to the new card(s). You wouldn’t want to do this right before you apply for a loan, but if you plan ahead of time it came be a great strategy.There are usually credit card companies with with a 0% introductory offer on balance transfers. This can be highly beneficial in reducing your over-all monthly expenses and interest payments.
- Limit inquiries for 120 days prior to applying for a loan. Especially when it comes to credit cards or other revolving debt. Installment debts such as car loans or mortgages are expected to be shopped for the best possible rates so these do not negatively impact your credit score as much as revolving and credit card inquiries.
- Ideally you should be showing at least 3 open and active credit lines. These can be car loans, student loans, or credit cards. Installment debt such as car loans or student loans usually helps increase your score more than revolving debt such as credit cards.
- Credit lines that have been open and active for a long time help increase your scores as well. If you have an old credit card that you rarely use – keep it open and use it occasionally so that it remains active. The longer you have it the more it helps your score.
- Don’t be late! Pay everything on time every time. Late payments can hurt your credit more than anything else and it can take a long time to rebuild your score if you have late payments that show up on your credit report.
Generally speaking, most lenders like to see a borrower with healthy savings accounts, retirement accounts and other liquid investments. Many lenders require you to have a minimum of two full mortgage payments (P.I.T.I.) in some type of liquid savings account. It is also common that a lender may require that the funds be ‘seasoned’ meaning that they have been sitting in your account for one to three months prior to obtaining the loan.
Your debt to income ratio is calculated by adding up all of your monthly debts and dividing it by your total gross monthly income. Most conventional lenders want to see this ratio be less than 43-45%.
Make sure totalk to at least three different lending institutions to make sure you are getting the best possible rate. Talk to credit unions and government agencies to make sure that you know what all of your loan options are. As an added tip, when before you go shop around, pull your own credit report and bring it along with you when you talk to the lenders. Pulling your own credit report doesn’t affect your credit score, while having a bunch of lenders pull it may. It is always a good idea to know what your credit score is beforehand anyway – that way if you spot a problem you can take necessary steps to fix it.