Buying a new house is an exciting time, but before you get caught up in the thrill of house hunting, you should take a step back and examine your credit. It’s almost unheard of for anyone to pay cash for a house these days, which means conversations with mortgage lenders will top your list of must-do’s once you decide you’re ready to buy a new home.
Mortgages & Credit Scores
Applying for a mortgage can feel somewhat invasive. You’ll have to provide deeply personal information about your financial situation including income, debts, job history, and credit ratings. A stranger will comb through all of that information to come up with a number and that number will reflect how much you can afford to spend on a home.
The most important pieces of information that the lender will look at is your credit rating and credit score, also called a FICO score. Lenders use these factors to assess you as a credit risk or debtor. The three digit score ranges from 300-850 (the higher, the better). The score is the result of equations that take into account five factors:
- Payment history: 35%
- Outstanding debts: 30%
- Length of your credit history: 15%
- Types of credit you’ve used: 10%
- Amount of new credit: 10%
Your credit score determines your credit rating: excellent (or exceptional), very good, good, fair, poor, very poor.
Even if you have a good income, a solid job history, and some savings for a down payment, a poor credit rating can derail your homebuying dreams. The lower the credit score and rating, the harder it will be to secure a home loan. Even if you do manage to get a loan, you’re likely to be charged a higher interest rate and will probably have to come up with a bigger down payment.
The good news is a poor credit score doesn’t mean you’ll never be able to buy a new house, because credit scores are not static. There are steps you can take to improve your score, and in some cases, you can build a strong credit rating to secure a home loan in under a year.
6 Tips to Repair Your Credit Score
1. Request A Credit Report
Did you know you can request a free copy of your credit report once a year? Few people do this, but it’s the best way to determine what your financial situation looks like to an outsider. Your credit report details your borrowing history, payment history, and number of credit inquiries. Contact each of the three credit reporting agencies – Experian, Equifax, and TransUnion – to request a copy of your credit report, then examine each report for accuracy. Follow up on inaccurate information because it could be affecting your credit score. If you find a lot of inaccuracies or even identity theft, contact a credit repair agency. These pros do this kind of work every day, greatly reducing your burden.
2. Check Your FICO Score
Credit reports do not contain your credit score. You’ll need to check your FICO score to view your three digit credit score. Ideally, you want to have a score of 650 or higher to secure favorable home loan terms.
3. Open Lines of Credit
It sounds counterintuitive, but using credit to pay for major purchases can actually boost your credit score. Why? Because mortgage lenders are looking at your ability to repay loans and your behavior as a debtor. They want to see that when you take out a loan, you are responsible enough to repay it.
According to Carolyn Warren, author of Mortgage Rip-Offs and Money Savers and Homebuyers Beware,you should keep older credit lines open and use the card occasionally. “A lot of people think, ‘I’ve got six credit cards, I’m going to close the four that I don’t use.’ But that’s a big mistake because your good accounts are adding positive points to your score.”
4. But Don’t Overdo It
Having some purchases on credit can help you, but applying for or having too many credit cards can hurt you. Whenever you apply for a credit card or loan such as a car loan or personal loan, credit inquiries will show up on your credit report. If you have several of these, especially if you didn’t take out the loan or open the card, lenders may get suspicious about your credit-worthiness, thinking that you didn’t get the loan because you were high-risk. Plus, the more you borrow, the more debt you can rack up; it’s easy to bite off more than you can chew.
5. Reduce Your Debt-to-Income Ratio
One important ratio that the lender will examine is your debt-to-income ratio. This is the amount of debt you have in relation to your income. The lower, the better. A mortgage can account for 30% of your income. A 10-12% ratio is ideal, because it’s enough to demonstrate creditworthiness without eating up too much of your income, which the lender will want available for their home loan.
6. Make Payments, and Pay On Time
If you have open lines of credit, make sure you are making regular payments, paying on time, and paying the required minimum or more with each payment. This is the best way to show lenders that you are a responsible debtor. Shoot for having at least a year of ‘on-time payments’ to demonstrate that you are a responsible debtor.
“Because paying credit bills on time is the most important factor in a credit score, going from paying one or more credit bills late each month to paying all on time could show an improvement in one to two months,” says Kevin Gallegos, Vice President of Phoenix Operations for Freedom Financial Network.
Don’t Despair Over Poor Credit
If you have gone over your credit reports and identified issues, but are paying your recent debts on-time and without trouble, don’t hesitate to talk to the lender. Lenders do have some discretion, even if the system and algorithms recommend not making the loan. You may not be able to get exceptional loan terms, but you might be able to get terms you can manage.
The best thing you can do is give yourself time. Take a peek at your credit scores several months to a year before you want to buy a new home so you know what kind of shape your finances are in. This will give you the time you need to clean up your credit before lenders start digging into it.
Liyya Hassanali is a Project Manager and Content Strategist for Kinship Design Marketing, a boutique agency that provides marketing strategies and content for architects, interior designers, and landscape designers. She is a 15+ year veteran of the marketing and advertising industry, working closely with her clients to provide written content that meets their marketing goals and gets results.
Liyya is passionate about home design and décor and is a confessed HGTV and Pinterest addict. When not providing content writing services for her clients, she can be found browsing home décor sites or spending time with her family.