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Cover story: Raising credit score for a home loan

- - Thursday, October 4, 2012

While most mortgage applicants know a good credit score is a key element for a loan approval, not everyone realizes raising your credit score by even a few points can make the difference between qualifying for a mortgage or not. In addition, if you are applying for a conventional mortgage rather than an FHA-insured home loan, you can pay a lower interest rate if you are able to boost your credit score into the next level.

"A borrower with a credit score of 702 will pay a one-fourth-percent higher interest rate than someone with a credit score of 720, even though those are both good credit scores," said Scott Davis, branch manager of Homestead Funding in Fairfax.

Mortgage applicants with severe credit challenges may need six months to a year or longer to improve their credit score, but those who are looking for a smaller boost can work with a lender and take steps for a faster score increase.

Mr. Davis said all consumers should check their credit score with all three reporting bureaus a minimum of three months before applying for a loan, although checking 12 to 24 months before applying would be better.

"One thing many consumers don't understand is that the credit score you see as a consumer is different from the one an auto dealership sees if you are applying for a car loan, and both are different from the score a mortgage lender sees," Mr. Davis said. "Each one is weighed differently. For example, the credit-score model I see weighs housing payment history more heavily than other factors."

In spite of the varied credit scores, consumers should check their credit report and credit score at least annually to look for errors and address any negative information.

"A lender can work with a borrower to figure out what they can do that will have the fastest impact on their credit score," said Marv Stanger, a senior loan officer with George Mason Mortgage in Reston. "The impact depends on your individual credit report. Some people have a perfect payment record but a lot of debt, while others have collections that need to be dealt with."

Some of the steps that can be taken to improve your credit score may seem counterintuitive, such as keeping accounts open if you don't intend to use them, Mr. Davis said.

"While it may make sense from a financial point of view to close two older credit card accounts and keep two new ones with lower interest rates, closing a credit card account will automatically lower your credit score," Mr. Davis said.

Paul Defngin, a senior mortgage banker with Apex Home Loans in Rockville, said that while there are certain rules to follow to improve your credit score, some situations can be tricky to navigate.

"If you have a small collection account, such as a medical bill you didn't know about from a few years ago, your instinct might be to pay it off," Mr. Defngin said. "The problem is, paying it off will make it look like a recent credit problem and will lower your score. It's better to leave it there and then take care of it after your loan has closed."

Mr. Stanger said his personal guideline is that if the only derogatory information on a credit report is more than two years old and he can qualify the borrower without fixing it, he leaves it alone until the mortgage loan has closed.

Mr. Defngin said borrowers with credit card debt should keep their balance on each card to 25 percent of the credit limit, but other lenders say 30 percent is acceptable.

"If you can pay down a credit card to under 30 percent of the limit or at least redistribute your debt by transferring a balance from one account to another so that each balance is less than 30 percent of the limit, you can improve your credit score by 20 or sometimes even 40 points," Mr. Stanger said. "Of course, that depends on what else is on the credit report."

Mr. Defngin said many lenders can request a rapid credit rescore if they have proof of a change, such as a copy of an updated credit card statement showing that the balance has been reduced. He said borrowers with enough cash would be better off if they can eliminate their credit card debt.

"Some people's credit scores have been damaged when their credit card company reduces their credit limit," Mr. Davis said. "While it may not always work, you can call your credit card company to see if they will restore your limit so that it doesn't look as if you have maxed out your card."

In addition to credit card debt, Mr. Davis said some consumers have items on their credit report that are dragging down their credit score. It may be in their best interest to pay off those items.

"If you didn't pay a D.C. parking ticket from 10 years ago because you didn't deserve to get it, that parking ticket could cost you $750 now and be hurting your credit score," Mr. Davis said. "It's better to pay $200 for something like a medical collection or an old parking ticket rather than not qualify for a loan or pay thousands of dollars because of higher interest rates over 30 years."

If you have disputed claims on your credit report, you will need to resolve those issues before a loan can be approved, Mr. Stanger said.

"Removing a dispute won't necessarily send your credit score up," Mr. Stanger said. "In fact, it could even lower your credit score. But until it's resolved, we don't really know what your true credit score is."

Some loan applicants have a problem that shouldn't be one: a lack of credit card use.

"It's a Catch-22 that you need a credit history in order to get a loan," Mr. Defngin said. "You need to open a credit card and use it and then pay it back on time in order to build a credit history. You need to use it for one or two months to show a repayment history."

Mr. Stanger said applicants without credit card debt can improve their score if they use a dormant credit card to charge something and then repay it.

"Sometimes the only option for someone without a credit history is to try for a loan approval based on nontraditional credit history, such as rent payments, insurance payments and utilities," Mr. Davis said. "Other than that, they may have to wait while they build a regular credit history."

Making long-term changes in your financial habits will do the most to improve your credit score, but for a short-term fix, borrowers should consult with a responsible lender who can make specific suggestions tailored to the individual's needs.