As a self-employed individual, you’re likely to face unique challenges in building and maintaining a strong credit history. Even though you can qualify for a self-employed mortgage with a credit score as low as 620, you’re more likely to secure more favorable interest rates if your credit score is in the upper 700s or higher. According to the Federal Reserve Bank of New York, the average credit score for newly issued mortgages in the first quarter of 2024 stood at 770. But what if your credit score isn’t ideal? With the right strategies, you can boost your credit score and secure lower interest rates.
Before we begin it’s important to note that we are not authorized to offer financial advice. However, we can provide guidance on appropriate resources for your situation. As a best practice, we strongly recommend consulting with a qualified financial advisor to discuss your specific circumstances and investment objectives. A financial advisor can conduct a thorough review of your credit report, identifying areas that need improvement. They can explain complex credit scoring factors and help you understand how different elements impact your overall credit score. This in-depth analysis allows for a more targeted approach to credit improvement.
This guide dives deep into our thoughts on how you can improve your credit score as a self-employed individual. From credit score basics and how they affect interest rates to 9 tips to improve your score and prepare for a mortgage application. Let’s jump into it!
Understanding Credit Scores
Knowing what a credit score is and how it’s calculated is the first step to improving your credit score. A credit score is a number ranging from 350 to 850 that represents how well you can manage your debt. This number is calculated based on several different factors, like your payment history, the length of your credit history, your credit utilization ratio, and the types of credit you have. Ultimately, lenders use this score to evaluate the risk of lending you money.
The two most common credit scoring models are FICO and VantageScore. As of 2023, the average FICO score in the U.S. was 715, which is considered “Good.” Since these two models use slightly different algorithms and weightings to calculate credit scores, you may find that your score between them varies slightly. Below, we’ve outlined the breakdown of how much each factor influences both credit scoring models:
FICO:
- Payment History: 35%
- Credit Utilization: 30%
- Length of Credit History: 15%
- New Credit: 10%
- Credit Mix: 10%
VantageScore:
- Payment History: 40%
- Depth of Credit: 21%
- Credit Utilization: 20%
- Balances: 11%
- Recent Credit: 5%
- Available Credit: 3%
Having a solid understanding of your credit score isn’t just good for mortgage applications but it can also benefit your overall financial health. Talk with your financial advisor if you are having credit issues — they are a great resource.
How Does My Credit Score Affect Mortgage Rates?
Although mortgages usually have a list of qualification criteria, credit score is a key factor that lenders check to evaluate a mortgage application. Besides allowing you to qualify, a strong credit score can come with an added benefit of securing a lower interest rate. Why does a higher credit score translate to a lower interest rate? It’s because lenders can feel confident that you’ll be able to make timely mortgage payments and you’re seen as less of a risk to them.
When it comes to how much your credit score affects mortgage rates, even a slight increase in your score can potentially make a difference. According to myFICO, these are the average 30-year fixed interest rates and monthly payments for a mortgage of $300,000 as of August 9, 2024:
As you can see, the difference between the highest credit score range vs. the lowest results in an additional 1.589% in interest. For a $300,000 home, this is a difference of $317 per month or $3,804 per year. Remember that for loan amounts greater than $300,000, the differences will be even greater than that.
| FICO Score | APR | Monthly Payment |
| 760-850 | 5.965% | $1,792 |
| 700-759 | 6.187% | $1,835 |
| 680-699 | 6.364% | $1,869 |
| 600-679 | 6.578% | $1,912 |
| 640-659 | 7.008% | $1,998 |
| 620-639 | 7.554% | $2,109 |
Common Credit Challenges for Self-Employed Individuals
Compared to traditional employees, self-employed individuals tend to face unique challenges when building and maintaining credit. This isn’t the case for all self-employed individuals, but none-the-less, a topic to dicuss. Some common credit challenges for self-employed individuals include:
- Irregular Income Streams: Self-employed individuals may have fluctuating or seasonal income, making it harder to show consistent earnings to lenders.
- Difficulty in Documenting Income: Without pay stubs, self-employed individuals must rely on bank statements, profit-and-loss statements, and tax returns, which can be more tricky to put together and may not fully reflect their true finances.
- Higher Scrutiny from Lenders: Some lenders may require more documentation and are often more cautious with lending to self-employed borrowers, leading to stricter approval criteria and potentially higher interest rates.
- Impact of Business Expenses: Self-employed individuals often have significant business expenses that can reduce their reported income on tax returns, which potentially lowers their qualifying income for loans.
- Credit Utilization Issues: Self-employed individuals may rely on personal credit to fund their business. This could result in higher credit utilization ratios, which can negatively impact their credit scores.
- Shorter Credit Histories: Some self-employed individuals may have shorter or less diverse credit histories if they’ve focused primarily on building their business.
Despite the challenges, improving your credit score as a self-employed individual isn’t impossible. Let us share some resources with you as to how.
8 Ways You Could Improve Your Credit Score for Better Self-Employed Mortgage Rates
Now that you’re up to speed on the basics of credit scores, let’s move onto the different ways you could improve your credit score. Since credit scores are calculated based on several different factors, making targeted changes to improve a specific factor can slowly increase it.
Again, our role does not include providing financial advice, but we can direct you to relevant resources that may be beneficial for your circumstances. We strongly encourage you to engage with a certified financial advisor to thoroughly examine your individual situation and investment goals before proceeding with any financial decisions.
1. Try Regularly Monitoring Your Credit Report
Regularly monitoring your credit is an important first step for everyone, not just self-employed individuals. You can get a copy of your credit report for free once a year through AnnualCreditReport.com. On top of that, you can get free weekly online credit reports directly from each of the three major credit bureaus—Equifax, Experian, and TransUnion.
Keeping a close eye on your credit report allows you to check for errors or inaccuracies that could be dragging down your score. Some examples of this include incorrect account information, outdated personal details, or unauthorized credit inquiries. If you notice any discrepancies, it’s important to dispute them as soon as possible with the associated credit bureau by providing supporting documentation to correct the mistake. Reviewing your credit report regularly can ensure that your credit score accurately reflects your debt management, which ultimately can help you qualify for better loan terms and lower interest rates.
2. Do Your Best To Pay Your Bills on Time
When you’re self-employed, demonstrating financial stability is key. Whether you’re looking at your FICO score or VantageScore, your payment history accounts for a large portion of your credit score, so consistently making payments on time can potentially boost your creditworthiness.
To make sure you never miss a payment, consider setting up reminders on your phone or calendar, or better yet, set up automatic payments through your financial institution. This way, you can avoid the risk of late payments, which can negatively impact your credit score. Each timely payment can help you build a positive payment history, proving to lenders that you’re a reliable borrower, even with the irregular income stream that comes with self-employment. Over time, these consistent on-time payments will pay off by helping you build and maintain a strong credit score. If you need any assistance with bill paying, reach out to your credit card holder or financial advisor.
3. Reduce Credit Card Balances
A key factor in your credit score is your credit utilization ratio, which measures how much of your available credit you’re using. Ideally, this ratio should be below 30%, meaning you’re only using a portion of your credit limits. For example, if your total available credit across all revolving credit lines is $20,000, then you shouldn’t be using more than $6,000 of it to keep your credit utilization below 30%. Keep in mind that high balances can negatively impact your score, which signals to lenders that you might be financially overextended.
To lower your credit utilization and boost your score, consider focusing on paying down debt strategically. You could try targeting high-interest balances first, making more than the minimum payment, and even consolidating debt to reduce the total amount of interest you’re paying. Steadily reducing your credit card balances lowers your credit utilization ratio, which shows lenders you can manage your debt responsibly. Email your financial advisor for assistance, and if you don’t have one, check out a variety of resources on Google for reducing credit card balances.
4. Avoid Opening New Credit Accounts
Every time you apply for new credit, something called a “hard inquiry” is recorded on your credit report, which can temporarily lower your credit score. Multiple hard inquiries in a short period could signal to lenders that you’re taking on more debt than you can handle. This could increase your perceived risk as a borrower.
Instead of applying for new credit, you could focus on managing your existing credit accounts responsibly. This includes paying down balances, making on-time payments, and keeping your credit utilization low. Demonstrating that you can effectively manage the credit you already have can help you build a stronger credit profile which positions yourself as a reliable borrower.
5. Maintain Long-Term Credit Accounts
Having a long credit history can help improve your credit score because it shows lenders that you have a proven track record of managing your debt responsibly over time. The length of your credit history is another key factor in calculating your credit score, with older accounts making a positive impact.
To keep these accounts active and in good standing, “use them periodically for small purchases and pay off the balances promptly.” This will help you keep the account open to continue contributing to your credit history, without accumulating any unnecessary debt. Additionally, consistently managing these accounts by making on-time payments and keeping balances low will reinforce your reliability as a borrower.
6. Aim To Diversify Your Credit Mix
Credit scoring models, like FICO and VantageScore, take into account the variety of credit accounts you manage. Those who can handle different types of credit are often rewarded with a boost in their credit score. A diverse credit mix could include revolving credit, such as credit cards, and installment loans, like mortgages, car loans, or personal loans.
Having a blend of credit types can show lenders that you can manage multiple financial obligations, which can potentially improve your credit score — this is not a given, but rather a factor. For example, responsibly using a credit card while also paying down an installment loan proves that you have the ability to handle both short-term and long-term debt.
7. Manage Business Finances
Managing your business finances strategically is especially important for self-employed individuals and entrepreneurs since business and personal finances are more likely to be intertwined. One of the key strategies here is to separate your business and personal finances, which not only helps you stay organized but also protects your personal credit from potential business-related liabilities.
If you have a CPA, have a conversation with your CPA. They can help develop strategies for growth, cash flow management, and long-term financial stability. Likewise, their expertise can often save you money through proper financial management and tax strategies.
To easily track your income, expenses, and profits, keep accurate and detailed financial records. These records will also help for both tax purposes and when applying for loans. Despite keeping your finances separate, using business credit responsibly can indirectly benefit your personal credit. For example, establishing and maintaining good credit with business credit cards or loans can help build a positive credit history, which some lenders may consider when assessing your personal creditworthiness.
8. Use Alternative Methods
If you’re having trouble building your credit, try using alternative methods that can help you jump-start your credit score. Here are some methods to consider:
- Get a Secured Credit Card: These credit cards require a cash deposit that serves as your credit limit. Making regular, on-time payments will help you build a positive credit history and you can potentially transition to an unsecured card.
- Become an Authorized User: Becoming an authorized user on someone else’s credit account allows you to benefit from the primary cardholder’s payment history, which can boost your own credit score if they manage their debt responsibly.
- Explore Credit-Builder Loans: These are typically offered by credit unions and community banks, which helps you build credit by making regular payments on a small loan.
- Speak with an Expert: Based on your unique financial situation and goals, a financial advisor can create a tailored strategy to boost your credit score. This may include advice on debt repayment prioritization, credit utilization management, and specific actions to address negative items on your credit report. They can also help you set realistic timelines for improvement.
Preparing for a Self-Employed Mortgage Application
A self-employed mortgage application requires planning in advance for a smooth approval process. To boost your chances of approval and secure more favorable loan terms, try timing your application when your credit score is at its best. Gather all the documentation you may need depending on the loan type and the lender’s requirements. With the Fed hinting at an interest rate cut soon, getting your application ready and building your credit now could put you in a good position to take advantage of an anticipated housing and refinance boom.
As a self-employed individual, you have a few different mortgage options available that were specifically designed for those with irregular income. These options include:
- Bank Statement Loans: Use your bank statements to qualify.
- P&L (Profit & Loss Statement) Loans: Use your business’ CPA-prepared P&L statements to qualify.
- DSCR (Debt-Service Coverage Ratio) Loans: Use your investment property’s rental income to qualify.
- Asset Depletion Loans: Use your liquid assets to qualify.
Defy Mortgage offers all of these options and more, helping you to find a tailored mortgage solution for your unique situation with competitive rates and flexible terms. Contact us for a free consultation to find the right self-employed mortgage for you.
Improve Your Credit Score FAQs:
- Why is my credit score important when applying for a mortgage?
Lenders use your credit score to assess your risk as a borrower, which influences the interest rate and loan terms you secure. A higher credit score can qualify you for lower interest rates, saving you money over the life of the loan.
- What are the main factors that affect my credit score?
The main factors that affect your credit score include payment history, credit utilization, length of credit history, types of credit accounts, and recent credit inquiries.
- How often should I check my credit report?
You should check your credit report at least once a year to ensure accuracy and monitor for any signs of identity theft or errors. You can get a copy of your credit report for free once a year through AnnualCreditReport.com.
- What should I do if I find errors on my credit report?
If you find errors on your credit report, you should immediately contact the credit bureau to dispute the inaccuracies, providing documentation to support your claim.
- How can I build a good credit history if I’m self-employed?
We can’t give you financial advice but we can guide you towards appropriate resources tailored to your situation. Given the complexity of financial decisions, we highly recommend consulting a certified financial advisor. As a self-employed individual, you can also build a good credit history by consistently paying your bills on time, keeping your credit utilization low, and maintaining long-term credit accounts — things to keep into account.
- How can I manage irregular income to avoid missing payments?
If you have irregular income, you could consider setting up automatic payments for your bills and maintaining an emergency fund to cover fluctuations in your income.
- What is a good credit utilization ratio, and how can I achieve it?
A good credit utilization ratio is generally below 30%, meaning you use less than 30% of your available credit limit.
- Is it better to pay off credit card debt or keep a balance for credit improvement?
Keeping a balance does not improve your credit score and can actually harm it if your credit utilization ratio is too high. Talk with your financial advisor if you have specific questions on this.
- How does opening new credit accounts affect my credit score?
Opening new credit accounts can temporarily lower your credit score due to hard inquiries and potentially higher debt amounts. Talk with your financial advisor if you have specific questions on this.
- Can I use my business credit to improve my personal credit score?
Business credit generally does not impact your personal credit score unless you personally guarantee the debt. Talk with your financial advisor if you have specific questions on this.
- What are alternative methods to build credit if I have no credit history?
If you have no credit history, you can build credit by using secured credit cards, becoming an authorized user on someone else’s account, or taking out a credit-builder loan. Speak with a financial advisor. Financial advisors provide continuous support, monitoring your progress and adjusting strategies as needed. They can help you stay accountable to your credit improvement plan, offer guidance on maintaining good credit habits, and advise on how to handle new financial opportunities or challenges without negatively impacting your credit score.
- When is the best time to apply for a mortgage to get the best rates?
The best time to apply for a mortgage is when interest rates are low and your credit score is in good standing. With the Fed likely to make interest rate cuts soon, working to improve your credit score now will help you get a more favorable rate when the time comes.
- What loan options do I have as a self-employed individual?
Loan options that you have as a self-employed individual include bank statement loans, P&L loans, DSCR loans, asset depletion loans, and more. Contact us at Defy and we can help you find the right self-employed mortgage for you.
- Can closing old credit accounts hurt my credit score?
Yes, closing old credit accounts can hurt your credit score because it reduces your available credit and can shorten your credit history.
