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Raising score for mortgage purposes? Don’t open new cards!

Summary

If you want to get your credit in shape for a mortgage approval, don’t open new credit cards. Instead, lower your balance on your existing accounts

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Dear Speaking of Credit,

My husband and I are in the process of purchasing a home. Our lender is using a credit simulator to raise our credit score.

He provided an action plan, which included paying off three credit cards each and getting a new secured card. We have completed the action plan provided within 30 days after receiving it.

My question is, can a secured card raise your score at least 40 points in 30 days?

The limit on the card is $200. I was told to use it one time and leave a $10 balance. I spent $25 on it thus far.

We desperately need our score higher in 45 days. Do you have any other suggestions? – Dionne

Dear Dionne,

The first of your two action items – paying off three cards – is a great one. The second one, opening a secured credit card, might just be one of the worst recommendations for someone in your situation I’ve heard in a long time.

So, let’s have a look at both pieces of your action plan, followed by a better way to get as many of those badly needed score points as you can in a short time.

Pay off card balances to improve credit score

Not surprisingly, some of the most reliable information we have on credit score behavior comes from the developer of credit scores used by the mortgage industry and the inventor of credit scoring as we know it, FICO.

According to a published FICO score simulation, someone with a score of 680 can quickly gain 10 to 30 points by paying down a single maxed-out card.

Though not an entirely apples-to-apples application to your situation, let’s say it’s possible to earn as many as 30 points by paying off those cards – as long as you leave them open.

  • Open cards with a $0 balance can continue to positively influence those credit utilization percentages – the amount you have borrowed compared to your credit limits – that make up almost 30 percent of your score well into the future.
  • Closing them after payoff will remove their credit limits and those $0 balances, and provide no such benefits to your score.

See related:  5 steps to a mortgage-worthy credit profileMortgage approved! Time to let your score slip?

Open a new secured card to raise score? Bad idea

Opening any new account to raise the score is simply a bad idea that is more likely to take points away, or have no effect, than increase your credit score.

Apparently your lender believes that a new card’s low utilization – 5 percent when a $10 balance is put on card with a $200 credit limit – will help lower your overall utilization when combined with your existing, more highly utilized, cards.

And he could be right if utilization were the only score calculation affecting your score, but it’s not.

Lowering your overall utilization by opening any new card, secured or unsecured, is more likely to hurt than help your score by:

  • Lowering your average account age.
    In the short run, this calculation (total number of months since each account was opened/number of accounts) is likely to result in a reduced average age following the adding of any new account to your credit report. A higher average age is always better for your score.
  • Reducing the age of your most recently opened account.
    As with average account age, this other age-related factor also adds more points the higher it gets. A shorter length of time is more likely to take points from your score than add them in the short run.
  • Adding a hard inquiry to your credit report at least one of the three credit bureauss.
    Before opening any credit card – secured or unsecured – the card company can be expected to check your credit at one of the big three credit bureaus. The typical inquiry reduces your score by about five points.

A better way to raise your score

Instead of spending $200 to establish a $200 credit limit on a new secured card, simply apply that same amount, or more, to one of your remaining balances for a lower overall utilization rate with none of the fallout from a new account.

Let’s take a look at two different examples that can explain this:

Example 1: Opening a secured card with a $200 credit limit

 

Cards on report / actionsTotal combined balanceTotal combined credit limitOverall utilization
6 existing cards$500$1,00050%
Add secured card with $200 credit limit$10$2005%
7 cards total (5 existing cards + 1 new card)$510$1,20043%

Example 2: Applying $200 to your total remaining balances instead of opening a secured card

 

Cards on report / actionsTotal combined balanceTotal combined credit limitOverall utilization
6 existing cards$500$1,00050%
Reduce existing balances by $200$200N/AN/A
6 cards total (no new cards added)$300$1,00030%

These two examples demonstrate how such an alternative can provide more help to your score than your lender’s action plan in at least three different ways:

  • Utilization is reduced by 13 percent, from 43 percent down to 30 percent.
  • No lowering of your average account age or length of time since your most recent account opening.
  • No new hard inquiries are incurred at any of the credit bureaus.

My recommendation to put score in shape for a mortgage application

Again, just by redirecting those $200 or more from a new secured card opening to an existing balance you can significantly lower your utilization with none of the downside caused by adding a new account to your credit reports.

If after paying off three cards each and lowering your remaining balances you still fall short of those 40 points over the next 30 to 45 days, don’t give up. You’ll be on the right track.

Just continue paying down those balances while leaving all existing cards open – without opening any new accounts.

Don’t worry, you’ll get there!

What’s up next?

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Published: May 17, 2018

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