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This post is part 2 in a series of posts entitled “How Can I Get a House” that outlines the basics of how to become a homeowner, including preparing your finances, your credit, the mortgage process, and working with real estate agents. If you’d like to start at the beginning of the “How Can I Get a House” series, click here.
Credit Is Important When Buying a Home
In today’s tougher mortgage lending marketplace, a good credit history is particularly important. It used to be that you could qualify for a mortgage with low credit scores, mortgage late payments, or a recent bankruptcy, but not so today. In today’s tougher mortgage lending climate, you need to have a pretty clean credit profile to even begin talking about qualifying for a home loan.
If you currently have some issues with your credit, it’s important to get started fixing them well before you begin house hunting. It can take some time for corrections to reflect in your credit file, so you don’t want to risk losing a house you really like because some unexpected credit issues held up your loan approval.
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What is a Good Credit Score?
Mortgage lenders require a credit report from the three major credit bureaus (Equifax, Experian, and TransUnion) that documents your credit scores, payment histories for mortgages, auto loans, personal loans, credit cards, and any derogatory information such as collections, foreclosures, judgments, charge offs, bankruptcies, liens, etc. Your credit score is considered to be highly predictive of the probability you’ll default on a loan, so lenders give it a lot of weight. The higher your scores, the better!
For mortgage qualifying purposes, scores below 620 are generally considered “bad” credit and scores above 720 are considered “good” credit. Everything in between is middle-of-the-road or “fair” credit. Ideally, you want to have all three scores in the mid 700s or better to get the best mortgage financing terms. If you already have a mortgage, lenders also are going to want to see that you have a perfect mortgage payment history for at least the last 12 months.
If your credit scores are already in the mid to high 700s or better, your credit is probably in good shape to qualify for a new mortgage. If your credit history is in the “fair” category and could use a little improvement, it’s possible you’ll still be able to qualify, but it would be to your benefit to get your scores up first because you’ll likely get a much better mortgage deal.
Fannie Mae significantly increased loan-level pricing adjustments last year for loan terms longer than 15 years and credit scores in the 600s, so it’s now much more expensive to get a loan with “fair” credit than it used to be. FHA is a little more forgiving, but stronger scores will definitely result in a better deal.
Some Tips for Keeping Your Credit Scores Strong
Remember, credit scores are considered predictive of risk, and risk is reflected in the loan pricing, so if you have credit scores in the “fair” range, it could cost you thousands (or tens of thousands) more over the life of the loan. It’s in your best interest to get the best deal possible, so take the time to groom your credit profile if you need to. The following are a few tips for doing this:
- Make all payments on time. The most important factor for keeping your credit scores strong is making all your payments on time. Your mortgage payment history is particularly important to lenders; not only does it impact your credit scores, but lenders will evaluate it as a separate qualification. These days you need to have a perfect mortgage (or rent) payment history for at least the last 12 months to qualify for a new mortgage.
- Check your report regularly and clear up any mistakes promptly. If you find errors on your credit report, contact the credit bureau that is reporting the offending account to get it cleared up as soon as possible. Where to find more information about disputing credit report errors can be found at the end of this post.
- Clear up open derogatory items. If you have old unpaid accounts that are still open as collections or charge offs, get them cleared up as soon as possible. Even if the accounts are small and old, they can still cause some damage.
- Always keep your credit card balances below 30% of the outstanding limit. The credit bureaus hit your scores hard if you have a high credit utilization - even if you make your payments on time. If you’re carrying a lot of credit card debt, it might be a good idea to first focus on paying down debt before attempting to qualify for a purchase loan. Having a lower debt-to-income ratio will make it easier to qualify anyway.
- If you have a home equity line of credit, verify that all three of the credit bureaus are reporting it as a mortgage debt. If it shows up as a revolving debt, then it will be treated by the scoring algorithms like a credit card and could damage your scores if you’re carrying a balance higher than 30% of the limit. If you do see this kind of error on your credit report, be sure to contact your bank to get it fixed.
- Keep older credit card accounts open. A lot of people (me included!) have made the mistake of closing out older, well-established credit card accounts because they think it will help their scores to reduce available credit. Big mistake! If you’re going to close out accounts, make sure to keep a few of your oldest ones open. Credit bureaus like to see long credit histories, so don’t chop your credit scores by chopping old accounts.
- Steer clear of cosigning. Even if the person you cosign for pays the bill on time, cosigned accounts can still cause some issues when qualifying for a home loan. If you do plan to cosign for somebody, make sure they will pay their payments on time. If they don’t, your scores will suffer and the bank will come after you for the unpaid debt.
Past Foreclosure, Bankruptcy, or Short Sale
If you have some major dings on your credit, such as a foreclosure, bankruptcy, or short sale, you probably have some work to do to rebuild your credit before you’ll be able to qualify for a new mortgage. Also expect that mortgage lenders will want you to wait a certain amount of time before they’ll lend to you (see my posts about waiting periods for foreclosure, short sale, and bankruptcy). Use this time to rebuild your credit profile so that when the waiting period is done, you’ll be ready to get the most favorable financing terms possible.
Get a Copy of Your Credit Report
If you haven’t checked your credit recently, federal law entitles you to a free credit report once a year from AnnualCreditReport.com. I highly recommend pulling your own credit before shopping for a mortgage so you aren’t surprised by anything that could result in a less favorable mortgage deal or not qualifying at all.
If some errors pop up on your credit report, be sure to get them fixed as soon as possible. It can take a few months for the corrected information to show up in your credit profile, so it’s important to get working on clearing up errors early so they don’t hold up the loan qualification process.
The FTC website has some great information about how to dispute credit report errors here.
Additional Resources
FTC Information on How to Dispute Errors On Your Credit Report
Equifax
Experian
TransUnion
AnnualCreditReport.com
Be sure to check back next week for my next post in the “How Can I Get a House” series. I’ll be covering how to prepare your financial profile for homeownership.
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