It should not come as a surprise that the past few years, especially 2020, have seen incredibly low interest rates on mortgages. As a result of these rates, many as low as 1.9%, people want to move or buy their first-ever home. While owing a home is an excellent investment, the only way to take full advantage of low interest rates is to have a good credit score.
A credit score, or FICO score as it’s commonly referred to, can range from 300-850. According to credit reporting agency, Experian, more than half of Americans have a fair credit rating, with the credit score breakdown as follows:
- 300-499: Very poor
- 500-600: Poor
- 601-660: Fair
- 661-780: Good
- 781-850: Excellent
A person’s credit score matters because it allows lenders, banks, to determine the risk associated with lending money and the chances of getting that money back. For example, a bank will give a lower interest rate to a person with a higher credit score because there is a proven track record of that person paying bills on time, not maxing out credit cards and carrying a low rotating amount of regular debt. The lending company recognizes that if it loans money to that person it has a higher chance of being paid back without missed payments and having to issue penalties. However, a person with a lower score will likely be given a higher interest rate because there is not an established track record of successful debt repayment and on-time bill pay.
Even with less than good credit, a lender may still be willing to issue a home loan. In some cases, this may be a subprime loan, which has interest rates that are higher than traditional loans and may come with additional fees. Talk to a realtor and lender about loan options and what the extra percentage points and fees may cost per month versus trying to pay down debt now and getting a lower rate later.
Steps to take
There are several steps someone can take to increase their credit score. The first is to pull a copy of the credit report and see what’s on it. This will tell if there are open accounts that need closed, outstanding debt that had maybe been forgotten or other accounts that need addressed. Each person is entitled to pull one free credit report each year; there is no need to pay for a credit report. To get a free report visit, www.annualcreditreport.com and fill in the details. Once the report is in hand, review it and resolve any errors and collections.
The next step is to begin paying down credit balances. Credit card debt accounts for 30 percent of a person’s FICO score, so higher credit card debt can mean a lower score. An easy way to put dents into that debt is to apply financial gains toward the payments. For example, a tax refund check that is put towards paying off debt will have a better return financially than a vacation or buying more stuff. Trying to put two monthly payments towards credit cards can also help lower the balance and avoid missing a payment.
Everyone has missed a payment at least once, and billers understand that accidents happen; however, if payments are frequently missed, the creditor will be less forgiving. Putting bills on auto-pay will take away the chances of a bill being paid late and incurring nasty penalty fees. Doing this can also help increase credit because it shows bills are paid on time.
As we prepare to say goodbye, and good riddance, to 2020, think about how to plan for a healthy financial future in 2021 and get started. Improving the credit score is an excellent New Year’s resolution that can have a tremendous impact by being offered lower interest rates and fewer fees.