How to Improve Your Credit Score Before Applying for a Home Loan

How to Improve Your Credit Score Before Applying for a Home Loan

Applying for a home loan is a significant financial decision, and your credit score plays a pivotal role in whether you’ll be approved and what interest rate you’ll receive. 

A higher credit score can boost your chances of approval and secure a lower interest rate, potentially saving you thousands over the life of your loan. 

So, how can you improve your credit score before diving into the mortgage application process? Let’s break it down.

Understanding Credit Scores in Australia

In Australia, a credit score is a numerical rating that reflects your ability to repay borrowed money based on your financial history. Lenders use this score to decide if they should approve your home loan and what interest rate to offer. A higher credit score generally means better loan terms and conditions.

Credit scores in Australia typically range from 0 to 1,200. Here’s a rough guide to what these scores mean:

• Excellent (800-1,200): You’re a very low risk to lenders and are likely to secure the best loan terms.
• Good (700-799): You’re a low risk to lenders and will likely receive favourable terms.
• Fair (600-699): You may be offered standard loan terms but need to improve your score.
• Poor (below 600): You may face higher interest rates or even difficulty in securing a home loan.

What does the average credit and finance stats for Aussies look like?

Average Credit Scores Vary by Age: Credit scores in Australia tend to increase with age. Younger Australians (18-30) have an average credit score of 731, while those aged 61-70 boast a higher average of 935. This trend reflects the longer credit histories and financial experience accumulated over time.

Household Debt Levels Are Rising: In 2021-22, the average Australian household debt was approximately $276,000, marking a 7.4% increase from the previous year. This figure encompasses various forms of debt, including mortgages, credit cards, and personal loans, highlighting the growing financial obligations among Australians.

Debt-to-Income Ratios Differ Across Age Groups: Australians aged 35-44 carry the highest debt levels, with an average debt-to-income ratio of 1.73 times the national average. This suggests that individuals in this age bracket are more likely to have significant financial commitments, such as mortgages and family expenses.

What Factors Influence Your Credit Score?

Understanding what affects your credit score can help you improve it:

1. Payment History (35%): Your payment history is the most significant factor. It shows whether you’ve paid your bills on time. Consistently making timely payments boosts your credit score and demonstrates reliability to lenders.
   
2. Credit Utilisation (30%): This measures how much of your available credit you’re using. A lower ratio, ideally below 30%, is preferred. High credit utilisation suggests you might be over-relying on credit, which could negatively impact your mortgage application.
   
3. Length of Credit History (15%): A more extended credit history provides more data for lenders to assess your credit behaviour. It shows that you’ve managed credit responsibly over time.
   
4. Types of Credit (10%): Having various credit accounts, such as credit cards, instalment loans, and retail accounts, indicates that you can manage different types of credit responsibly.
   
5. New Credit Inquiries (10%): Hard inquiries, like those from applying for new credit, can temporarily lower your score. Soft inquiries, such as checking your own credit, don’t affect your score.

Steps to Improve Your Credit Score Before Applying for a Mortgage

Check Your Credit Report

Before applying for a home loan, it’s essential to check your credit report. Carefully review the report for errors, late payments, or closed accounts that could impact your score. Address any discrepancies promptly to avoid potential issues with your mortgage application.

Pay Down Credit Card Balances

Reducing your credit card balances is one of the most effective ways to boost your credit score. Start by listing all your credit cards, including their balances and limits. Prioritise paying off the cards with the highest interest rates or smallest balances first. Consider making extra payments beyond the minimum to accelerate the process. Avoid adding new charges to your cards while paying down existing balances.

Avoid Opening New Credit Accounts

When preparing for a home loan, avoid opening new credit accounts. Each new application triggers a hard inquiry on your credit report, which can temporarily lower your score. Instead, focus on managing your existing accounts and resist making new purchases that could increase your debt load. If you must open a new account, do so well before starting the mortgage process.

Reduce Outstanding Debts To Help Your Credit Score

To improve your credit score, focus on reducing outstanding debts. List all your debts and decide which ones to address first. Paying off high-interest debts can save you money over time. Choose a payment strategy that aligns with your financial situation, such as the snowball method (starting with the smallest debts) or the avalanche method (starting with the highest interest rates). Make extra payments whenever possible to reduce your principal balance more quickly.

Pay All Bills On Time

Paying all your bills on time is crucial for maintaining a positive credit history. Timely payments improve your credit score and show lenders that you are a responsible borrower. Set up automatic payments, create a budget, or use calendar reminders to ensure you never miss a due date. Prioritise essential payments like bills, home loan repayments, and utilities.

Keep Old Accounts Open

Keeping old credit accounts open can positively impact your credit score. The length of your credit history contributes to your overall score. Even if you don’t use these accounts regularly, keeping them open can demonstrate long-term credit management. Make small purchases occasionally to keep these accounts active, and consider setting up automatic payments to avoid missing any due dates.

Address Errors and Discrepancies

Errors in your credit report can negatively impact your score, so it’s crucial to address them promptly. If you find inaccuracies, dispute them with the credit bureaus. Provide any necessary documentation to support your claim and follow up to ensure that the errors are corrected. This proactive approach can help prevent issues with your mortgage application.

Understand the Impact of Credit Inquiries

Frequent hard inquiries can lower your credit score, so it’s important to understand their impact. While shopping around for the best mortgage rates, multiple hard inquiries within a short period are typically treated as a single inquiry if done within a certain timeframe (usually 30 days). This way, you can compare rates without significantly affecting your credit score.

Utilise Credit Monitoring Tools

Credit monitoring tools can be an effective way to keep track of your credit health and spot any issues early. Many credit monitoring services offer real-time updates on changes to your credit report, alerts for suspicious activity, and tips for improving your credit score. By regularly monitoring your credit, you can stay informed about your financial status and address any problems before they affect your mortgage application. 

Some popular credit monitoring services in Australia include Credit Savvy and Finder. Investing in these tools can provide peace of mind and help you proactively manage your credit.

Manage Existing Debts Wisely

In addition to paying down credit card balances, it’s important to manage your existing debts wisely. If you have personal loans, car loans, or other forms of debt, ensure you’re making regular payments and not missing any due dates. 

Consider consolidating high-interest debts into a single loan with a lower interest rate if it will help you manage payments more effectively and reduce your overall debt burden. Managing your debts responsibly not only helps improve your credit score but also makes you a more attractive candidate to lenders. Aim to keep your overall debt-to-income ratio low, as this reflects positively on your ability to manage and repay loans.

Build Positive Habits To Improve Your Credit Score

Building and maintaining positive credit habits is essential for long-term financial health. Regularly review your credit statements, pay off balances promptly, and avoid unnecessary debt. Consider setting up a financial plan that includes a savings strategy and responsible credit use. Developing these habits will not only improve your credit score but also contribute to your overall financial stability.

Consult a Trusted Financial Advisor To Discuss Improving Your Credit Score

Consulting a financial advisor can be a valuable step in preparing for a mortgage. A financial advisor can review your financial situation, assess your credit report and score, and provide tailored advice. They can also help you understand how much mortgage you can afford based on your income and expenses and guide you on saving for a down payment by exploring assistance programs.

Once you’ve worked hard to improve your credit score, consider how refinancing might benefit you in the future. Refinancing involves replacing your existing mortgage with a new one, typically to secure a lower interest rate or better terms. By refinancing, you might be able to lower your monthly payments, reduce the total interest paid over the life of the loan, or switch from an adjustable-rate to a fixed-rate mortgage. It’s a valuable option to keep in mind as you continue to manage and improve your financial health.

Make Your Credit Work For You

Improving your credit score is a crucial step in securing a favourable home loan and getting the best possible terms. By following these steps and taking proactive measures, you can strengthen your credit profile and enhance your chances of mortgage approval. 

A little effort now can pave the way for a smoother mortgage process and help you secure your dream home on the best terms. Start today, and you’ll be on your way to confidently achieving your homeownership goals.

Ready to Take the Next Step?

Get in touch with our expert loan strategists at Rateseeker for an obligation-free chat, who can guide you through every step, from tips on boosting your credit score in order to satisfy lenders to finding the best home loan options tailored to your needs. With our support, you’ll be well on your way to securing the perfect mortgage and achieving your homeownership dreams.