July 24, 2018.
There are few things worse than finding your dream home and not being able to buy it because you can’t secure a home loan. Financing problems are often caused by problems with your credit history or a low credit score. Fortunately, there are several things that you can do to improve your score before you ask for a mortgage approval.
The biggest reason to boost your credit score is to improve the odds that your mortgage application is approved. A low credit score is a red flag to lenders, and many will simply deny your request outright. A very low score may even disqualify you for government loan programs — such as VA, USDA, or FHA mortgages — which are often more forgiving when it comes to credit issues.
But there is more to getting a mortgage than just being approved. The terms of your loan are also based, in part, on your credit score. Your interest rate, as well as other fees, are affected by your creditworthiness. Lenders may delay approval of your loan until you can pay off debts or get questionable credit report entries removed. This delay could keep you from buying the house that you really want.
Here are some tips for getting your credit score and reports mortgage-ready.
Improving credit to buy a house is critical: Here’s how you can do it
1. Work on your credit score early.
The time to start working on your credit score is long before you’re ready to apply for a mortgage. Even if you believe that you have good credit, it is still possible to unwittingly knock your credit score down several points by applying for a credit card or making a large purchase. Plus, there is always the risk that your identity is stolen or that a credit reporting bureau posts inaccurate information on your report. Think hard about your plans. If homeownership is a possibility within the next year or two, it’s time to start working on your credit.
2. Don’t guess your credit score or assume it’s correct.
Did you know that there is more than one credit score? The original credit scoring system, now known as FICO(R), offers different types of scores to lenders, insurance companies, and other businesses that are concerned with consumer credit issues. In addition, credit bureaus offer their own scores, some of which are only intended to help consumers get a general idea of what their creditworthiness is. This means that if you order a credit report from a credit bureau, the score attached to it may not be what a mortgage lender will consider when deciding to offer you a loan.
The same holds true for your credit reports. You are entitled to one free copy of your credit report annually from each of the major credit bureaus: Experian, Equifax, and TransUnion. Many credit experts recommend that you check these reports more often, even though you’ll have to pay a nominal fee to do so. This will give you a chance to correct any errors before a lender sees them. In addition, you’ll be able to see if there is any negative, but accurate, information that you can address before approaching a mortgage lender.
3. Avoid hard inquiries.
If you’ve ever checked out your credit report, you may have seen a list of credit inquiries listed on the report. These inquiries are from companies that are checking your credit for a variety of purposes, including issuing credit, offering a loan, getting approval for an insurance policy, renting an apartment, or getting internet service. In some cases, these inquiries can knock several points off your credit score. However, not all such inquiries do damage to your score. Unfortunately, it’s not always clear which types of credit checks can be problematic.
Credit professionals make the distinction between a so-called “hard inquiry” versus a “soft inquiry.” A hard inquiry is a credit check performed by a company after you’ve applied for some type of financing, including loans, credit cards, and credit lines. Because you are actively seeking credit or a loan, a hard inquiry is detrimental to your score. A soft inquiry, on the other hand, can be generated by requesting your own credit reports, an employer doing a background check, or even businesses and lenders searching consumer databases before offering a pre-approved credit card or line of credit. Soft inquiries will not damage your credit history.
The problem is that it isn’t always possible to distinguish between the types of inquiries treated as hard versus soft by credit bureaus.
For example, it is not unusual for landlords and property management companies to run a credit check as part of their rental application process. In some cases, this is treated as a soft inquiry. In other situations, it’s deemed a hard inquiry. The same may hold true for renting a car, opening a bank account, or requesting cable service. Even though a hard inquiry’s damage to your credit score is minimal, it’s not something you want to happen directly before you apply for a mortgage.
To protect yourself, avoid applying for credit, except when absolutely necessary. Avoid doing so entirely in the months before trying to buy a home. In addition, don’t consent to a credit check by a business until they tell you whether they run a hard or soft inquiry on your report.
4. Don’t close old accounts.
When you tell people that you’re looking to buy a home, you may get well-intended advice about how to improve your credit score. It’s important to fact-check this advice because credit score modeling has changed significantly over the years.
People who bought a home decades ago may tell you to close out any old credit cards or lines of credit that you no longer use. This is because earlier credit score models penalized people for having access to “too much” credit, even if they weren’t using it. That has changed, however. Now your credit score is improved by having a large amount of credit that you do not use. In addition, the length of time that you’ve had an account also has an impact on your credit score: The older an account, the better it is for your score. In general, it’s a good idea to keep these old accounts, unless they’re costing you lots of money in annual fees.
5. Avoid large purchases and cash advances.
Because your score is improved by not using all of your credit, avoid using credit to make large purchases in the months leading up to a mortgage application. This is true even if you are able to easily afford account payments. Avoid cash advances for the same reason.
Unfortunately, using cash to make a large purchase isn’t always a good option either. Lenders will look at your banking statements and take note of any unusual deposits or withdrawals. Keep spending to a minimum until you’ve closed on your home.
The final word: Healthy credit can make buying a house easier
Buying a home can be incredibly stressful. You can reduce your stress by getting your credit score into healthy shape, reducing the possibility of a loan rejection or having to settle for a mortgage on less favorable terms. Preparing ahead of time is a good way to ensure that there are no surprises when a lender pulls your credit.
Questions about your credit? Cornerstone loan officers offer a free mortgage loan credit report and are always happy to help.
If you are unsure about your credit situation, you may wish to speak with a housing counselor who has been certified by the United States Department of Housing and Urban Development. A housing counselor can review your finances and credit. They can then make recommendations on ways to improve your score and find the right mortgage for your situation.
Zoe Aston is an experienced real estate investor and broker. She’s worked with clients whose credit was on the outs. And she’s helped them get back on track in order to qualify for their second mortgage application.
Cornerstone Home Lending and its affiliates do not provide financial planning, tax, legal or accounting advice. This material has been prepared for informational purposes only. It is not intended to provide, and should not be relied on for, financial planning, tax, legal or accounting advice. You should consult your own financial planning, tax, legal and accounting advisors before engaging in any transaction.
For educational purposes only.
Sources are deemed reliable but not guaranteed.