Improve your credit score

I'm moving this post over from a blog that I started a couple years ago. This post was from January 2006. When I wrote this, there was no housing crisis, and I was suggesting that people should be improving their credit scores so that they could refinance easier. Now that there is a very real housing crisis, this seems a bit more prescient than I thought it was at the time...

Time warp on, have fun reading:

Last post I mentioned the need to clean up your financial past to better prepare for a re-finance in the future. I'd like to pipe in now to make that list I promised. Keep in mind, there will be a test and the results will likely be held against you. ;-)

1. As I said before, The first, most important thing to do in *every* financial situation is pay your bills on time. People who loan money like to deal with someone who is predictable and stable. Think about it, Would you loan someone money who "occasionally" let his bills slip or "sometimes" was a bit late on paying the bills because of (insert you last lame excuse for a late pay here) - Probably not. Payment history counts for around 35% of your credit score!

If you have past due bills now... Pay them and stay current. You will need to show a history, and you can expect to have to explain every incident of late pay that is found, so the fewer the better.

2. Unless you are an heiress, you probably don't need fifty credit cards running around. However, DO NOT close accounts just prior to looking for a house. If you have open cards with no or low balance on them, leave them for now. Your credit score is based partially on the ratio of open credit versus balances. Closing cards with no balances on them will tip this ratio against you.

The more appropriate approach would be to make sure that your cards have no more than 25% of the available balance used and that (as mentioned above) all payments have been made on time. Of course, there might be those clever individuals out there thinking... "Aha, I can just go out an open a few more cards now so that I can get a better ratio!" Well... Not really. This will also look bad on a report. Just pay down the ones you have, it's far easier in the end.

3. Don't make any major purchases. This includes Cars, Home Theater setups, Tweaked out computer systems or anything that you (or the bank) might consider a big purchase. The bank will look at any large purchase as a liability. Even if you purchase the car with cash out of pocket, this will look bad for you. Remember that the mortgage company will be looking at your cash reserves and will wonder why a large chunk left your possession just prior to the purchase.

4. Don't switch jobs. Remember, be predictable and stable. People who are predictable and stable stay in their jobs for a long time and have certainly been in their most recent job for the last two years or more. A stable person would not even think of looking to take on the responsibility of a mortgage payment unless they had a history of predictable income they could count on ;-)

5. Get a copy of your credit report. They are pretty cheap and will give you great insight into what surprises your lender will be finding. You will have far more power being able to say with a clear conscience "Yes, I've cleaned that nasty collection of unpaid adult video rentals right off my credit score, here is the letter of resolution." Keep in mind that this usually will cost a few bucks to do. The advanced knowledge and ability to clean up problems will be worth the cost. Besides, you are doing all of this months before you are planning to buy, right?

If you do have errors on your credit report, you can have them removed. This will take a bit of effort on your part however, and might take some time as well. So the sooner you get started the better. There is a great article located at that can help you clean up errors if you find any on your report.

6. Don't apply for any other credit. This should be obvious from a couple of the above points, but I'll reiterate it again for fun. No credit cards, no car loans, no furniture rental agreements, no TV payment plans or store credit cards. Nothing. Nada. Nix. Every enquiry into your credit will cost you 5-10 points off your score. Every open card will count against you. Every payment you are responsible for will lower your available ability to pay your new loan payment.

7. Keep the money that you plan on using for a down payment in your account for more than a month. The bank will want to know that you have had this money for a while. Some may want to know where it came from.

8. Get to know your Debt to Income ratio. The simple math used to determine what you can afford according to most banks is as follows: you can probably afford 28% of your total gross income (from all verifiable sources) as a house payment. They also assume that you must pay out no more than 36% of your total for ALL of your bills combined, including your house payment. This is considered a debt to income ratio of 28/36.

The trick is to manage your debt to a level that closely resembles this. If you have way to many cards that have balances or car payments that are too big, find a way to pay them off or reduce them if possible. The bank will be considering minimum payments, so don't feel that you have to pay things "off" if you don't want to. But you should expect to encounter problems if your math does not quite equal their vision of where you should be.

9. Get in good with your landlord (if you rent) - especially if you have made any late payments in the past. It's likely the mortgage company will contact your landlord to ask for your payment history. The last thing you want is to show that you have had trouble paying rent.

10. If you are self employed, get ready for a rough ride. Ditto if you own your own company or have a larger than 5% stake in a public company. People that manage their own destinies are just plain unpredictable and thus can't be counted on, Right? Well... Not really. We know better. But the banks don't, they will use that against you until your eyes are bleeding.

Here is the rub. For most self employed people, the goal is to show as little profit as possible to eliminate the yearly tax bill. This results in a lower than usual income, and thus... A lower than acceptable debt to income ratio. Simple, but there are ways around it. Get statements of future income from your clients prepared, this will provide proof of this years income without having to provide even an inkling of the deductibles you plan on taking. Prepare to show the last two years tax returns, this is the equivalent of the requirements "normal" people have of showing the last two pay stubs. Most importantly, start focusing on your debt to income ratio immediately. If you don't pay your self a salary, now is a good time to start.

Well... That's all I have for now. If you feel that I've left anything out... Please feel free to make a comment.

p.s. Happy New Year!

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