How to Improve Your Credit Score Enough to Qualify for Rock-Bottom Mortgage Rates

(source)

Mortgage interest rates are at record lows. Property values have dropped dramatically since 2007, in almost every city across the country. When you combine affordability with inexpensive financing, it seems like buying a home is a pretty safe bet – and right now it's a great time to be on the borrower side of the equation.

The problem is, in order to qualify for the sub-4% mortgage interest rates screaming at you from all those news articles, you have to have very good credit scores. According to Informa Research Services, the national average interest rate for a 30-year fixed rate mortgage was 3.933% as of August 24. But in order to earn that rate, your middle FICO score (that is, the middle of the FICO scores calculated by the three credit bureaus, since mortgage lenders check all three of your scores) has to be at least 760.  You can quickly get your free Experian credit score from CreditSesame.com.

So how do you put yourself in the best position, credit-wise, so you can end up with an impressive interest rate? Here are four strategies to get you started.

1.  Pay down your credit card balances

FICO scores are primarily driven by your payment history and your indebtedness. And while it's not that easy to simply get rid of negative information from your credit reports, dealing with debt is slightly more actionable.

Consumers with FICO scores above 760 have balances on their credit cards that represent an average of 7% of their credit limits. That means you'll want to aggressively attack your credit card balances and hold off on using the cards until you've closed on your loan. I realize that 7% is almost the same as paying off your cards and that isn't a realistic goal for many of you. That's OK, because the scoring system will still reward you for lowering the percentage -- even if you can't get it to an optimal number.

2. Or ask your creditors for a credit limit increase

An alternative to the strategy above is to address the limits on your credit cards. That 7% figure is a product of dividing your balances by your credit limits. And, since this is just a simple math problem, you can accomplish the same score improvement by asking your credit card issuers to increase your credit limits.

Call your credit card issuers and inquire about a credit limit increase, but make it clear you don't want them to pull your credit reports. You don't want new inquiries to show up and possibly lower your scores. Most credit card issuers give their customer service folks some latitude regarding small credit limit increases without a full blown credit report and score review.

3. Pay off retail store cards and other credit cards with small balances

Another key factor in your FICO score is the number of accounts with a balance greater than $0. You can improve your score almost immediately if you eliminate what I call “nuisance balances” -- those single or double digit balances on your retail store credit cards.

4. Don't apply for new credit until you close on that mortgage loan

Mortgage lenders have gotten smarter about verifying your credit risk throughout the underwriting of your loan… not just when you first apply. There's a chance the lender will pull your credit reports and scores again, just before closing, to see if you've applied for any new credit. Avoid applying for anything until you have the keys! This won't improve your scores but it will keep you from lowering them.

Each of the aforementioned strategies will either result in almost immediate score improvement or defend your already sufficient score from damaging actions. This means better credit scores and cheaper interest rates on your mortgage loan, and anything else you choose to finance afterwards. Now you just have to figure out who's going to mow the lawn.

John Ulzheimer is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO and Equifax, John is the only recognized credit expert who actually comes from the credit industry. He is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and a Contributor for the National Foundation for Credit Counseling. Follow him on Twitter here.