Hey Team,
Ihave been working on paying off some of my debt because I want to buy a house. I’ve been hearing a lot of contradicting information about improving my credit score so I can get the best interest rate. Someone told me I need to pay down my debt and close all my accounts once paid off.
Is this the best way to improve my score? Is there anything else I should be doing?
Sincerely,
Deeply in debt
Dear Deeply in debt,
The credit industry can be so frustrating!
The truth is your credit score is made up of several different metrics, some more important than others. You see, over 65% of your score is based on how often you make your payments on time (35%) and how much of your credit limits you are using (30%). Focusing your efforts on making sure you make your payments on time every month and paying down your debt will make the biggest impact on your score!
The rest of your score breaks down like this:
15% - Length of credit history
10% - How many different types of credit you have (credit cards, car loans, mortgage, etc.)
10% - How many hard inquiries you have for new credit
When we are looking to make a major purchase, like a home, we want to avoid closing any credit accounts. When we close these accounts, there is the potential for your score to go down because you could be reducing the length of your account histories. For example, let's say you have three credit cards, and you just paid off your oldest card that had 15 years of history on it while your others are less established. If you were to close that older card, you would be losing out on 15 years of credit history! The information will still show up on your credit report, but it won't be used in the calculation of your score anymore. Although 15% isn’t a lot, preserving it is helpful overall.
We also want to avoid opening up new lines of credit, especially leading up to securing additional financing! Opening up new lines of credit could disqualify you for your home loan even if you’ve already been approved for the loan. Your lender will check more than once during the homebuying process. When you take on more debt, you are now a bigger risk to your lender. Also, if we’re being honest, we really care about how stable you are with your finances, and consistent borrowing patterns start to build a rocky path to instability.
So, the moral of the story is:
- 1. Make your payments on time
- 2. Pay your debt down as quickly as possible
- 3. Don't close your accounts if you are trying to make a major purchase.
- 4. Don't open new accounts, especially if you don't REALLY need them.
