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Over the past 20 years, I’ve bought three homes, but took out over a dozen mortgages.
That’s right, I took out far more mortgages than one per home because early on I used second mortgages to avoid having to pay private mortgage insurance (PMI), and on many occasions I was able to reduce my costs by refinancing loans as interest rates dropped.
During that entire two-decade period, I worked with one specific mortgage guy because he always provides outstanding service, saves me money, and makes sure there are never any hiccups at closing. I’ve even followed him from lender to lender as his career progressed. My loyalty is to him, not a specific bank.
Here’s one insider tip he gave me, which I’ve used several times to score the best possible mortgage interest rate.
Saving Money on Mortgages by Boosting Your Credit Score
Unless you’ve been living under a financial rock forever (or have just recently graduated from school), you know that a good credit score lets you access loans with lower interest rates. It’s easy to understand why this is so. A good score tells lenders you’re less likely to default on a loan, so they don’t need to charge you as much of a risk premium.
What Affects Your Credit Score
As explained by MyFICO, your credit score is determined using five main criteria:
- Timely Payments: If you never miss a payment, lenders can be confident you’ll most likely continue to do your best and pay on time. Weight: 35% of your score.
- Length of Credit History: When you’ve demonstrated your ability to handle credit responsibly for a long time, lenders know it’s more likely you’ve overcome challenges, and thus are likely to be able to overcome future setbacks without defaulting. Weight: 15%.
- Mix of Credit Accounts: Different types of credit lines behave differently. An auto loan payment is constant and if you stop paying you’ll lose your car. A credit card may surprise you with a much larger bill if you recently made an unusually large purchase, but you can pay a small fraction and not default (and pay a lot in interest charges). Successfully navigating a wide range of types of credit instills confidence in your ability to handle credit responsibly. Weight: 10%.
- Number of Accounts Opened Recently: If you open too many accounts too close together (e.g., within a two-year period), this may signal that you’re heading into a debt tailspin. Weight: 10%.
- Credit Utilization Ratio: The fraction of your available credit that you actually owe signals to prospective lenders how much of a safety margin you have before you’re maxed out and headed for default. Weight: 30%.
How to Boost Your Credit Score
From the above list, it’s clear that the best thing you can do for your credit score is to never miss a(nother) payment. However, this isn’t a quick fix. If you missed a payment last month, that’ll ding your score significantly for the next couple of years.
Over time, your credit history length will naturally increase, but this too won’t happen overnight or even over a year.
You can certainly open new credit lines of types you’ve not had before, but while that might help your “mix of credit accounts” factor, it’ll hurt your “number of accounts opened recently” factor for the next couple of years. Again, not a quick fix.
This brings us to the last option – reducing your credit utilization ratio. Luckily, if you have enough cash on hand, this is one place where you can boost your score quickly.
In a piece on the high cost of credit card debt, I show a graphic of how quickly and severely you hurt your credit score by having balances on your credit cards. Conventional wisdom tells you to keep your ratio under 30%, but that’s highly misleading. Borrow as little as 8% of your available credit and your score drops by about 40 points! Borrow 26%, lose over 70 points!
Worse, when a lender pulls your credit, they don’t care if you pay all those balances off in full whenever you get your statement.
The flip side of this is that if you’re one of those who use credit cards responsibly, you can boost your credit score almost instantly when needed, by paying off your credit card balances right away instead of waiting for the statements to come in.
Step-by-Step Guide on Boosting Your Credit Score for a Refi
When you apply to refinance your mortgage, the lender will pull your credit from all three major bureaus, and will most likely use the middle of the three resulting scores.
Depending on the details of the loan they’re arranging for you, they may be able to offer you a significantly better rate if your score is even a single point above a threshold. This threshold might be a score of 720, 740, 770, or even 800.
Say you’re targeting a score of 770, but you know you’re floating around 735, what to do?
Here’s a step-by-step guide, assuming you have enough cash on hand to pay off your credit card balances in full right away, and still have enough left over that your lender isn’t concerned about your liquidity.
- Tell your lender what you’re planning to do, and ask how much you’d need to pay off to bump your score high enough for the best rate.
- Ask for a contact name, fax number, and email address at the lender for letters you’ll arrange from credit card issuers (see below).
- List all your current credit card balances.
- Send payment to each issuer, paying off your full current balance right away rather than waiting for the statements.
- Monitor your balances over the next few days until you see the payments post and the balances drop to (or near) zero.
- Call the phone numbers on the back of your cards and ask the reps to send you letters stating that your then-current balances are $0 (or whatever they are if you had to use a card for another purchase since you sent the payments). Some will agree to email the letter to you (which you can forward to your lender), but those that won’t do that should still be happy to fax it to your lender.
- Once all the letters are in your lender’s hands, ask to have your credit scores updated.
Say you have a total credit limit of $100,000, and you use your cards to pay on average $15,000 a month, paying that balance off in full when the statements arrive. If your total current balance is say $10,000, paying that off in full should give you a 40-point bump in your score, moving you to 775.
The Bottom Line
Using credit cards responsibly can boost your credit score over the long run. It can also score you some nice rewards (e.g., 2% cashback on Citi’s Double Cash card, redeemable by check if you want, 5% reward on all Amazon purchases using Amazon Prime Visa, redeemable toward future Amazon purchases, etc.).
However, even if you pay off all your cards in full each month, your credit score drops even when you have a current balance that’s less than 10% of your total credit limit. The above shows you how to use this to quickly boost your credit score, if and when you need that to get the best mortgage refi rate possible.
About the Author
My career has had many unpredictable twists and turns. A MSc in theoretical physics, PhD in experimental high-energy physics, postdoc in particle detector R&D, research position in experimental cosmic-ray physics (including a couple of visits to Antarctica), a brief stint at a small engineering services company supporting NASA, followed by starting my own small consulting practice supporting NASA projects and programs. Along the way, I started other micro businesses and helped my wife start and grow her own Marriage and Family Therapy practice. Now, I use all these experiences to also offer financial strategy services to help independent professionals achieve their personal and business finance goals.
Disclaimer: The information in this article is not intended to encourage any lifestyle changes without careful consideration and consultation with a qualified professional. This article is for reference purposes only, is generic in nature, is not intended as individual advice and is not financial or legal advice.