If homeownership tops your list of short- or long-term goals, it’s important to understand behaviors that can affect your credit score. Credit isn’t the only thing lenders consider when approving mortgage applications. Banks also look at your income and work history. But even if you earn enough and you’re employed, bad credit can put the brakes on your application, or at the very least, result in a higher interest rate.
Fortunately, there’s plenty you can do to build your credit score, and it starts with recognizing behaviors that drive it down in the first place.
1. Overusing Credit Cards
Some people are the epitome of self-control. They can have multiple credit cards in their wallets, yet maintain low or non-existent balances. This isn’t the case for every cardholder.
If you want to improve your credit, paying bills on time might be a no-brainer. You think you’re doing okay if you’ve never missed a payment. But while it’s important to keep a good payment record, it’s just as important to control credit card balances. If you max out your credit cards or keep these balances close to your max, you’re unknowingly hurting your credit score.
Credit cards are a type of revolving debt, and with this type of debt, a high balance can damage your credit score more than other types of credit accounts, such as mortgages, auto loans and student loans. With any type of revolving credit line, you’ll want to keep a low credit utilization ratio, which is the amount you owe on credit cards compared to your limits. This ratio is used to calculate your credit score. Ideally, your ratio should not exceed 30%. A higher ratio can lower your credit score and make it harder to qualify for mortgages.
2. Closing Credit Card Accounts
Shutting down a credit card account feels liberating, and you probably consider it a logical move if you’re trying to improve your credit score. Yet closing a credit card account can increase your credit utilization ratio, ultimately damaging your score.
Keep in mind that your credit utilization ratio takes into account your total outstanding credit card balances and your total credit limits. Let’s say you have two credit cards, each with a $1,000 credit limit. If you have a zero balance on one card and a $600 balance on the other card, your credit utilization ratio is 30%. This is within the recommended range because your total credit limit is $2,000. Cancelling the credit card with a zero balance drops your total credit limit to $1,000 and raises your credit utilization ratio to 60%, which is double the recommended range.
It’s okay to simplify and get rid of a few credit cards. Just make sure you do the math beforehand, and only cancel a card if you’re able to keep your ratio low.
3. Gambling With Your Good Credit
Cosigning a loan or credit card can help another person build his credit history and get ahead financially. But if you’re thinking about buying a house, you need to consider how this decision could affect your ability to get a mortgage.
You might have a difficult time saying no to your child, sibling, parent or best friend. And you might be this person’s only hope for getting financing. However, the risks of cosigning greatly outweigh the benefits. Not only because cosigning creates a new debt under your name and decreases purchasing power when you’re ready to apply for a mortgage, but also because you’re giving another person power over your credit score. There’s no guarantee this person will act responsibility. If they pays late or default, your credit score can take a hit.
4. Excessively Shopping for Credit
If you’re rate shopping and multiple lenders request your credit report, your credit score will not decrease as long as these inquiries occur within a 30- to 45-day window. But if you're the type of person who applies for credit just for the sake of applying, or to get 10% off your purchase at retail stores, you can damage your credit score over time.
Each credit inquiry, or new credit application, takes one to two points off your credit score. An occassional inquiry might not make or break your credit rating, but if you apply for 10 new credit cards in a two- to three-month period, your credit score could potentially take a 20-point hit. These inquiries might decrease your 630 credit score down to 610, and that can destroy your chances of qualifying for a conventional mortgage loan, which requires a minimum credit score of 620.
5. Ignoring Your Credit
Never assume your credit is good enough to qualify for a mortgage. If you can’t recall the last time you checked your credit, then you're overdue for a peek. Every consumer can receive one free report from each of the bureaus a year. Order your credit report from AnnualCreditReport.com, or contact the credit bureaus directly. This is one of the best ways to ensure information is accurate on your credit report, and to confirm that you haven’t been a victim of fraudulent activity. Disputing and correcting errors adds points to your credit score and helps you qualify for a mortgage.