For nearly 9 out of 10 buyers, house hunting also means mortgage hunting. And that means paying extra-keen attention to your credit score, which can determine whether you get the best possible interest rate or a more costly home loan — or whether you get approved at all.
You probably know the basics of earning good credit — like consistently paying your bills on time and avoiding big credit card balances — but there are some lesser-known behaviors that can put an unexpected dent in your credit score.
One thing people often do without realizing the impact it will have on their credit scores is to open a bunch of accounts in a short period of time, said credit industry expert John Ulzheimer. “That could considerably lower the average age of your accounts, and load your credit reports up with credit inquiries,” Ulzheimer said.
Applications for new credit — whether it’s a car loan or a credit card — comprise up to 10 percent of your FICO score, with each lender’s “hard inquiry” on your credit report capable of knocking off a few points. Meanwhile, the length of your credit history — the longer, the better —accounts for 15 percent of your score. So opening multiple new credit cards this year will swiftly skew the average age of your accounts to be much younger.
And yet, another surprise credit score-killer is not having enough accounts to buffer against those minor ups and downs. “Consumers who have “thin” credit reports — those with fewer than three accounts — are more susceptible to radical score movements by doing even seemingly benign things, like charging a larger balance one month than normal,” Ulzheimer said. A healthy mix of credit cards and auto and student loans can help insulate your credit score from such shifts. “Avoidance is not a credit improvement strategy, as some would have you believe.”
There was a time when unpaid parking tickets or library fines could hurt your credit report if the balances were turned over to a collection agency, but not anymore. “The credit bureaus will no longer accept collections for noncontractual debts,” Ulzheimer said. However, a string of unpaid rent or cellphone bills could still land on your credit report, said Beverly Harzog, a consumer finance analyst and credit card expert for U.S. News & World Report.
“It’s still really important to pay your rent on time. It’s not the type of thing that’s typically reported to the credit bureaus, but if you miss a couple months, that could be,” Harzog said. “Even if it doesn’t get picked up by FICO, it’s still on your credit report,” she added, which mortgage lenders will also look at while reviewing your application.
There are more quirky ways your credit score can drop, but to understand why these seemingly minor actions can end up swaying your score, it’s important to understand the term “credit utilization,” which accounts for 30 percent of your FICO score. Your credit utilization rate is the amount of your available credit limit you’ve used up — the lower, the better. For example, imagine Maria has two credit cards with a combined limit of $10,000; if she’s carrying a $2,500 balance, her utilization rate would be 25 percent.
Harzog said the standard recommendation is to keep your utilization rate under 30 percent (and under 10 percent if you’re really trying to improve your credit score). If Maria charges a $1,000 plane ticket, bringing her balance to $3,500, her utilization rate could immediately hit undesirable territory — and her score could suffer, even if she pays off the charges at the end of the month (at which point her score would rebound).
But your utilization rate can wreak havoc in other ways, too. You’ve probably heard that closing an old credit card can lower your credit score, which is true — but it’s not because you’re dropping a ripe old account from your credit history, which Ulzheimer says is a myth. “As long as they’re still on your credit reports, closed accounts are still considered in the age-related metrics of scoring models,” Ulzheimer said. The only reason closing a credit card can lower your score is because you lose the available credit limit associated with the account, he said, which can abruptly change your utilization ratio.
Say Maria closed one of her two cards, and it had a $6,000 credit limit. That would suddenly leave her with a $2,500 balance against just a $4,000 limit, for a credit score-sabotaging 63 percent utilization rate. “So closing a card with a large limit is really the bad move here, not necessarily closing an old card,” Ulzheimer said.
That’s why your score could also suffer a surprise drop if a card issuer suddenly lowers your credit limit. Card companies might reduce your available credit for a variety of reasons, but usually it’s because you’re doing something that makes them nervous, Harzog said. “Sometimes that can be as simple as applying for too many cards at one time,” Harzog said. “So don’t apply for anything, not even one card, for a few months before you apply for a mortgage.”
Of course, one thing you will be applying for is a home loan. Thankfully, credit scoring models don’t penalize you for this too much, Ulzheimer said. “In FICO’s scoring models, those inquiries are ignored for their first 30 days. Afterward any mortgage inquiries that are within 45 days of each other are counted as one single inquiry,” he said. In VantageScore’s model, he added, all mortgage lender inquiries placed within 14 days of one another are counted as one.
To the extent that there’s an impact on your score, Ulzheimer said, those combined mortgage inquiries will usually cost you only a few points at the most. But what might surprise you is just how crucial a few points can be, depending on where you fall in the credit score spectrum.
On a $400,000 mortgage, for example, a borrower with a 761 FICO score might save $50 a month and more than $18,000 in total interest versus someone with a 758 score, according to FICO’s Loan Savings Calculator, because rates improve above the 760 tier. Borrowers can expect to face ever higher rates as they fall into lower credit score tiers. Dropping from 660 to 639 — a difference of just 21 points— can tack on a whole percentage point to your mortgage rate, adding $235 a month to your mortgage payment and $84,461 in lifetime interest payments. “Going from 825 to 821, who cares?” Ulzheimer said. “Going from 620 to 615, that’s a problem. You’ve crossed a risk tier.”
A FICO score of 760 or better is the goal when it comes to getting the best mortgage rates, Ulzheimer said. The path to getting there is no surprise, though — it just takes consistent effort: Always pay your bills on time, keep your credit card balances low, and avoid opening too many new accounts at once.
Jon Gorey blogs about homes at HouseandHammer.com. Send comments to [email protected]. Follow him on Twitter at @jongorey. Subscribe to our free real estate newsletter at pages.email.bostonglobe.com/AddressSignUp.