Here’s why your credit score matters and how to improve it

In just a matter of months, mortgage rates have surged from just over 3% for a 30-year fixed loan to just north of 5%.

As potential homebuyers follow those figures, there is one thing they may be overlooking: their credit score.

The three-digit number has a big impact on the interest rate you’ll get on a mortgage. The higher the score, the lower the rate.

Credit scores range from 300 to 850. A good score is 670 to 739, very good is 740 to 799, and 800 and up is considered excellent, according to FICO, a leading credit scoring company.

The mortgage rate for a 30-year-fixed loan is now 5.15%, according to Mortgage News Daily. To land that rate, your credit score should generally be over 740, said Glenn Brunker, president of Ally Home, which provides mortgage services and products.

Under 740 and lenders start to add in more costs to reflect the additional lending risk, he said. That is either added to the interest rate or it can be paid separately in what’s known as points. One point equals 1% of your mortgage loan.

“It doesn’t sound all that significant but when you think about adding an extra $20, $40 or $60 a month to your monthly payment as a result of a lower credit score, it can materially change your monthly budget and what you can afford,” Brunker said.

With mortgage rates expected to continue climbing higher, consider making moves to lower your credit score to take advantage of the best rates available. Here’s what you can do.

Your credit report is essentially a history of your credit activity and includes payment histories, credit card balances and other debt. A number of factors on that report help determine your credit score.

Pulling your report before you apply for a mortgage or preapproval, ideally a few months in advance, will give you time to correct any issues you find.

Traditionally, you are allowed one free credit report a year from the three main credit scoring companies: Experian, Equifax and TransUnion. You can reach out to each directly or you can access them through annualcreditreport.com. During the Covid-19 pandemic, free access was upped to once a week — but that expires April 20.

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Also bear in mind that on July 1, Equifax, Experian and TransUnion should remove any medical debts that were sent to debt collectors and eventually paid off.

“That could instantly improve somebody’s credit score a lot,” said Ted Rossman, senior industry analyst at Bankrate and CreditCards.com.

“Someone with an otherwise good credit score could lose 100 points or more if they have medical debt.”

Late or missed payments can knock down your score.

The easiest way to avoid that is to set up automated payments for your bills.

“The consistency of paying bills on time will improve your credit score,” said Tom Parrish, head of retail lending product management at Chicago-based BMO Harris Bank.

Lenders will look at whether you have high balances on credit cards.

Even if you pay your credit card bills in full each month, you may still have a high utilization rate, Rossman said.

For example, if you make $3,000 in purchases and have a $5,000 limit, you are using 60% of your available credit. Try to keep it below 30%, Rossman said. Those with the best credit scores keep it below 10%.

Making an extra payment in the middle of the billing cycle can help knock the balance down before the statement comes out.

Some community banks and credit unions offer credit-building loans, which are designed to help the holder establish good credit as they make payments.

You’ll pay interest, although some lenders may reimburse the costs after the loan is repaid.

If you are looking to purchase a home, hold off on any other big-ticket items, like a car.

Also, don’t open new credit cards or new lines of credit, which will result in more inquires for your credit sore.

“If you have a high level of inquires, it drives your credit score down,” Brunker said. “It looks as if you are in active pursuit of additional credit and therefore at a higher risk.”

If you decide to boost your credit score before applying for a mortgage, bear in mind there’s the possibility interest rates could be higher by the time you do try to get a loan. Then again, home prices may come down.

“We don’t know what is going to happen with rates long term and home prices,” Parrish said.

Brunker suggests those with a credit score between 700 and 740 move forward with the purchase of a home, while still making an effort to clean up their credit score. For those with lower scores, first ask yourself if homeownership is the right move and whether you understand the true cost of homeownership, he said.

“If the answer remains yes, I would consider taking a pause for a few months,” Brunker said.

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