How to Make Sure You're Credit-Ready to Buy a Home
Checking your FICO Scores at the right time before applying for a credit card or loan puts you in the best position for approval and competitive terms.
For many people, buying a home is one of the most significant financial commitments they'll ever make. While mortgage interest rates are low compared with other types of credit, even a small difference can cost you tens of thousands of dollars over the life of your loan.
Your FICO® Scores are a crucial consideration for mortgage lenders and having good credit long before you start house hunting will help improve your odds of scoring a low-interest rate and maximize your savings.
Having good FICO Scores is especially important in a seller's market, which the coronavirus pandemic has created in several areas. Housing inventory had already reached record lows before the pandemic, but as demand has risen over the past year, inventory remained especially low.
In seller's markets like these, having a better chance of securing financing could give you a leg up on other buyers whose credit histories aren't as polished as yours.
5 Steps to Take to Help Get Your Credit Ready for a Mortgage
Excellent FICO® Scores and credit is important. If you're hoping to buy a house in the next year or two, taking certain steps now can make a big difference and help you obtain affordable financing. Here are five areas to focus your efforts.
1. Pay Down Debts
Your credit utilization rate is one of the most influential factors in your FICO Scores. It represents how much of your available revolving credit, like credit cards that you're using at a given time. The higher your balances are relative to your credit limits, the more it can damage your credit.
The good news is that your credit utilization is recalculated every time your credit card companies report your new balance, which typically happens once a month. So if you pay down a credit card with a high utilization rate, your FICO Score may reflect that quickly thereafter.
Another reason to pay down debts, in general, is because of your debt-to-income ratio, often called DTI for short. Your DTI represents the percentage of your gross monthly income that goes toward debt payments. Mortgage lenders typically have minimum standards for what your DTI can be, but the lower it is, the better.
2. Get Caught Up on Past-Due Payments
Your payment history is the most important factor in your FICO® Scores, making up 35% of the calculation. Negative items will remain on your credit report for seven years.
While you can't fix the past, getting current on your accounts can help prevent further harm that could put your mortgage chances in jeopardy.
As you work to get caught up on late payments, also make it a goal to pay all your debts on time going forward. Over time, a positive payment history can help reduce the impact of past late payments.
3. Limit Large Purchases
Even if you're paying off your credit card in full every month, a high balance on the date your credit card company reports account activity to the credit bureaus may still result in a high credit utilization rate.
As a result, it's best to avoid large purchases on your credit cards, if possible. Also, note that making large purchases and paying them off will result in lower cash reserves, which is another factor lenders may consider to determine whether you can afford a down payment and closing costs.
4. Check Your Credit Report for Inaccuracies
Considering how much data credit bureaus maintain for hundreds of millions of consumers, inaccuracies are relatively rare. But they can happen.
It's always a good practice to check your FICO® Scores and credit reports regularly to know where you stand and make adjustments as needed. But another reason to review your reports is to watch out for inaccurate and fraudulent accounts and information.
The credit bureaus have a process to dispute errors — they'll investigate the issue to determine whether or not to remove it from your report. If you can get a negative item removed through this error disputing process, it could have an immediate impact on your FICO Scores.
Just keep in mind that the credit bureaus will not remove information that's legitimate. If your claim is legitimate and you have supporting evidence for your claim, make sure to provide that to the credit bureaus to help increase the chances that you'll get the error removed.
You can get a copy of your credit report from each of the three national credit bureaus at AnnualCreditReport.com. Typically, you can get one free copy every 12 months from each bureau, but through April 2021, you can request one weekly without needing to pay.
5. Avoid New Credit Several Months Before You Plan to Apply
A mortgage loan isn't just a big commitment for you; it's also a big commitment for the lender. As such, anything you do that could increase the chances that you default on the loan could hurt your chances of getting a low-interest rate or even getting approved at all.
Applying for a new credit card or loan in the months leading up to your mortgage application won't likely make a huge dent in your FICO® Scores. But it can increase your DTI and leave less money in your budget to make future mortgage payments.
So if you're hoping to get a new credit card sign-up bonus or buy a car, wait until after your mortgage closes to apply.
Other Ways to Help Ensure a Lower Rate
Your FICO® Scores are a crucial element in the mortgage underwriting process, but it's not the only factor lenders consider. In addition to having a good FICO Score, here are some other things you can do:
Make a large down payment: The more money you put down on your home, the less you need to borrow from a lender. A larger down payment not only reduces your monthly payment but also represents less risk to the lender, which could result in a lower interest rate. Use this calculator to help you decide how much money to put down on your home.
Purchase a cheaper home: In conjunction with a large down payment, opting for a less expensive home could help you score a lower rate. In general, mortgage lenders like your housing costs to be 28% of your gross income or lower. If you go much lower than that, it could make the loan more affordable.
Shop around: Comparing mortgage rates from multiple lenders is one of the best things you can do to get a lower rate. Each lender has its own criteria for determining interest rates and one may offer a lower interest rate than the others, despite the fact that they're all looking at the same information. Work with a mortgage broker or fill out an application with several lenders to see which one can give you the best terms.
Buy discount points: Discount points allow you to exchange an upfront cash payment for a slightly lower interest rate. Each point costs 1% of the mortgage amount and typically reduces your interest rate by 0.125%. So, if you have a $200,000 mortgage and a 4% interest rate, paying $2,000 could drop your rate to 3.875%. If you're planning to stay in the home long enough to recoup that $2,000 in monthly savings, it can be worth it. If not, you're better off with the original rate. Use this calculator to help you decide if mortgage points are a good option for you.
Throughout the mortgage process, take your time to research your options and legal strategies you can use to purchase the home you want at a reasonable rate.