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Do you dream of having a home to call your very own one day? If you’re like most people, the answer is a resounding, “YES!”
If you do, you’re likely to run into a pretty significant challenge: You probably don’t have hundreds of thousands of dollars in your bank account to buy a home with cash. (See also: The Process for Buying a House With Cash)
So what do you do?
Again, if you’re like most people, the next step to getting the house of your dreams is to get a mortgage loan.
And once you start shopping for a mortgage, you’ll find that not all loans are created equal. Lenders will charge you different interest rates based on their judgment of your financial responsibility and your ability to repay the loan.
The more responsible they think you are, the better the interest rate you’ll get. And the better the interest rate you get, the more money you’ll save.
So how do most lenders judge your sense of financial responsibility? They do it by looking at a three-digit number — your credit score.
How Your Credit Score Affects Interest
Check out this mortgage loan savings calculator, which shows how your credit score impacts the total amount of interest you pay on a loan. For the sake of simplicity, I’m using the traditional 30-year fixed mortgage with a loan amount of $200,000. (See also: Should You Choose a 15- or 30-Year Mortgage?)
With these numbers, let’s say your credit score is in the worst range, between 620 and 639. Based on the calculator’s results as of 12/24/13, you’ll end up paying $223,150 in interest over the life of your loan.
On the other hand, what if your credit score was in the best range, between 760 and 850? In this case, you’d end up paying a total of $153,186 in interest.
In other words, if you have the best possible credit, this is how much you’ll end up saving over the life of your loan — more than $69,000.
What could you do with an extra $69,000? Better yet, how much would it hurt to lose more than $69,000?
So now that you’ve seen how your credit score affects the amount of money you’ll pay, you may be wondering, “How do I get my credit into the best range?” (See also: Rebuild Your Credit in 8 Steps)
How to Improve Your Credit Score
Here are four proven steps to raise your score.
1. Pay Your Credit Card Bills on Time
According to myFICO, your debt payment history makes up 35% of your credit score — the largest chunk. So the single best thing you can do to improve your credit is to have no late payments. (See also: How to Avoid Late Fees)
2. Get Out of Debt, and Stay Out
The amount of money you owe makes up 30% of your credit score — the next largest chunk. If you’re using a high percentage of your available credit, lenders may think you’re more likely to make late or missed payments. So by paying off your debts, you’ll be using less of your available credit, and your score will improve.
3. Keep Your Cards, and Keep Them Active
Repeat Steps One and Two over and over again. Lenders like to see a long history of credit. It makes up 15% of your score — the third largest chunk. So the longer you hold a credit card, the better it’ll be for your credit score. And if you ever get a new card, don’t close your old one. That could hurt your score. (See also: 10 Surprising Ways to Hurt your Credit Score)
4. Ask for More Credit
As a warning, you should only do this if you’re completely out of credit card debt and you pay your balance in full. Otherwise, the extra credit may tempt you to spend more. This is related to Step Two. Again, since the amount you owe makes up 30% of your score, by increasing your available credit, you lower what’s called your credit utilization rate. This helps improve your score. To get more credit, simply call your credit card company, and tell them you’d like more credit because you’re thinking about making a large purchase in the future. It’s that simple. (See also: Habits of Responsible Credit Card Users)
Checking Your Score for Free
If you’d like to monitor the progress on your score as you follow these steps, you can check your score by going to Credit Karma or Credit Sesame and signing up for an account at no cost to you.
Building good credit, like building wealth, doesn’t happen overnight. But by following these steps over the long term, you’ll be sure to save the most amount of money possible when you finally find your dream home.
Have you taken any of these steps to improve your credit? How well did you do?