How can I improve my credit score?

The first thing to do to improve your credit score is to get your score from the three major credit companies — Experian, TransUnion, and Equifax — as previously described. While you are not entitled to get your credit score for free each year, it will cost you less than $10 to get your credit score from each agency, and you can order it at the same time as you order your free annual credit reports. It is worth purchasing your credit score from all three agencies as they are often different, and you will not know which agency's score your potential mortgage company will use. Along with giving you your score, the agencies will give you advice on how to raise it. Most of the advice is common sense:

• bring debts that are delinquent current;

• be sure to pay bills on time;

• pay off small debts; and,

• cancel unnecessary credit cards.

If you have a low score because you have little or no credit established, you may want to apply for a no-fee credit card or two. While people who pay cash for everything may be the most financially responsible, they are not improving their credit score by doing so. The credit companies want to know how you have handled credit in the past, not how you have avoided using it.

What if I am not ready to get a mortgage right now?

Each positive step you take can raise your score ten to twenty points over a three-month period. Major steps, such as substantially lowering your debt, will result in a higher increase. If you are thinking that you would like to buy a house in a year or even longer, now is the time to start working on your credit history. Since you must allow yourself at least three months to change your score — longer to raise your score an appreciable amount — do not wait until you are ready to buy to start trying to raise your score.

From the Expert

The idea behind improving your credit score is to make you look more financially responsible so you qualify for a better loan.

What are income-to-debt ratios?

The next thing an underwriter will examine is how much money you earn and how much you owe. From this information, income-to-debt ratios are created that become benchmarks for deciding what type of loan you can afford.

The traditional ratios were 25%-35%. This meant that the most your mortgage payment should be was 25% of your gross (total) income. If your salary was $4,000 per month, you should pay no more than $1,000 per month for your mortgage payment, which included principal, interest, property taxes, and insurance (PITI). This ratio of income to PITI is called the top ratio.

You were then allowed an additional 10% of your income to pay for other debts, like a car loan. Your monthly payments for all debts, including your mortgage, could not exceed 35% of your gross income. This is called the bottom ratio. If your ratios exceeded these numbers, you would have to seek a loan from a high-risk lender and pay higher interest and fees.

While the income-to-debt ratios allowed became a higher percentage of your gross income over time, because of the recent problems with loan defaults, lenders are now adhering to more traditional guidelines. The days of lending to borrowers based on unrealistically high ratios are over, at least for the foreseeable future.

Another variation is a high mortgage ratio and a low overall or total debt ratio. If you are going to pay 30% of your income for your mortgage expenses but have no other debt, you are above one ratio but below the other. Your lender's policy and your credit score will be the determining factors in whether or not you will qualify for a mortgage.

In most instances, the policy of the individual lender will determine the ratio allowed. You can simply ask a prospective lender the numbers it uses to give its most favorable interest rate.

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