April 17, 2018.
Most homebuyers have misconceptions about credit. On the internet, credit myths abound, but when buying a house, the purpose of the credit score is simple. If you have a higher credit score, you can be eligible for a better interest rate on your mortgage, along with your auto loans and other lines of credit.
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Why should you improve your credit before buying a house?
It’s simple. “Protecting and improving your credit score prior to purchasing a house positions you for the best loan terms,” John Savin, owner of Savin Wealth Management, says. “Lending institutions will review your creditworthiness to determine if you qualify for a loan. A higher credit score shows you are able to have credit extended to you and repay it.”
If you’re a first-time homebuyer, your credit score is likely to be lower than a repeat homebuyer, confirmed the Urban Institute in their 2015 report, since you’re still building your credit profile. This is perfectly okay and even expected by your lender. Whether a first-time or repeat buyer, it’s still worthwhile to take a closer look at your credit to protect or improve your score before buying a house.
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A lender will look at your credit score and credit history to get an idea of the risk of lending to you, Allison Bethell, Fit Small Business staff writer, real estate investment expert, commercial and residential house-flipper, and licensed Florida realtor, explains. “The lower the score, the higher the risk. So, if a lender will qualify a low-score buyer at all, the interest rate may be higher, and the down payment amount may be higher as well.”
Thankfully, Bethell says, once you improve your credit score, you’ll save money by becoming eligible to receive a lower mortgage interest rate.
6 tips to get your credit score in shape before buying a house
No matter how much attention your credit score needs before buying a house, using one or more of these tips can help to improve your creditworthiness in the eyes of a lender:
1. Buy only what you can afford to pay off each month.
Rating: Easy.
Start out with baby steps to get your credit back on track. Don’t overspend, and don’t make any large purchases when you’re preparing to purchase a house, Bethell says. “These purchases on credit cards will affect your debt-to-income ratio and your credit score. A good rule of thumb is to maintain no more than a 25 percent balance on each card (if you can’t afford to pay it off in full). For example, if your credit card limit is $10,000, don’t leave a balance of more than $2,500 on the card.”
2. Pay all bills and current debt on time.
Rating: Easy.
Ready for baby step number two? Paying bills and debts on time is essential to good credit, and paying bills in full, if possible, is even better, Savin says. If you can master this tip, you’re ahead of the game, and changes in your credit score are likely to follow. Only 35 percent of credit card users pay off their balance each month, Time Money reported in 2016.
3. Check your credit report.
Rating: Medium.
Based on the Fair Credit Reporting Act (FCRA), you’re entitled to a free credit report each year from one of the three nationwide credit reporting agencies — allowing you to keep closer tabs on your credit. “Be proactive and check your report for accuracy, along with clearing up legal issues, like charge-offs, collections, liens, and judgments,” Savin says. “Doing this will minimize potential questions a lender will surely bring up. Depending on the severity of items being repaired on your credit report, it can take a few months to years to reflect a higher score.”
Credit reports are also individual, Kansas State University researchers remind us, so couples considering buying a house together should monitor and upkeep their own credit reports.
4. Pay off loans with high interest rates.
Rating: Medium.
As the next course of action, Bethell urges soon-to-be homebuyers to stop wasting money by paying credit card and debt interest. Instead of tackling the smallest balances first, Bethell suggests paying off any loans or credit cards with high interest rates so you’re not paying on excess interest each month. Big debt can be overwhelming, but paying $1,000 toward a $5,000 credit card bill at 15 percent interest will have more financial impact than paying off a $1,000 credit card bill at 4 percent interest.
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5. Reduce your ratio of debt to available credit.
Rating: Hard.
The amount of debt you carry, or your debt-to-credit ratio, makes up 30 percent of your FICO score. Hitting your credit limits by taking on more debt can negatively impact your credit score. “An advanced approach to raising your credit score is reducing your ratio of debt to available credit and debt to income,” Savin says. “The lower the ratio, the more favorable it is for you.”
To keep your credit utilization below 30 percent, and to keep your credit score healthy, Experian recommends reducing your ratio of debt to credit by paying down high credit card balances. Not using credit cards until balances are reduced, tracking spending and sticking to a budget, and working to increase income can also help to lower your ratio of debt.
6. Write down your financial goals and stick to them.
Rating: Hard.
Having patience and sticking to a budget seems easy, until you put a pen to paper — or a finger to a smartphone app — to do it. To support long-term creditworthiness, Bethell suggests keeping track of your spending and remembering to put money aside for a rainy day. And, stay mindful of credit rule number one: Continue to spend within your means. “Don’t get off track with silly little purchases that add up. Don’t try to keep up with the ‘Jones’ — oftentimes the ‘Jones’ are in debt themselves,” she says.
Discovering blemishes on your credit score before buying a house can be daunting, and yet, there’s a silver lining. Savin suggests that future homeowners use this as an opportunity to become experts on their personal finances. “Understanding your cash flow, spending habits, and lifestyle goals will empower you to make smarter decisions.” Becoming disciplined with your money mindset, he says, will in time take you from undesirable to super-prime credit.
When in doubt, or for any credit-related questions that need answering, your loan officer is only a phone call away. You can also plug your information into our free LoanFly app to get prequalified for a mortgage in minutes, and we’ll automatically send you your credit score.*
*During normal business hours.
For educational purposes only. Cornerstone is not a credit repair company. Please contact a qualified professional for specific guidance.
Sources are deemed reliable but not guaranteed.