Get Your Credit Score in Shape for Homeownership

Written by Posted On Tuesday, 07 August 2018 08:31
Get Your Credit Score in Shape for Homeownership Fox Business

Your credit score alone does not determine the rates and terms of your conventional home loan. Yet it can be the deciding factor in lender approval. If your mortgage is backed by Fannie Mae or Freddie Mac, you will have to apply with a minimum credit score of 620--no exceptions.

FHA loans are more forgiving, requiring applicants to have a minimum credit score of 580 in order to qualify for a 3.5% down payment. Yet given the fact that nearly a third of all Americans have a credit score below 601, credit challenges are quite a reality for prospective homebuyers.

If you are preparing to purchase your first home, it’s vital to both understand your credit score and history and ensure it’s on its best possible footing for a home loan application. The higher your credit score, the greater your “creditworthiness,” meaning that you’ll be more likely to qualify for lower interest rates and better mortgage terms.

Plunging into credit histories may be at the bottom of your list, particularly if you loathe financial management, but here are a few things you can do to ensure your digits are in good condition for homeownership.

Request a Copy of Your Credit Report

All Americans are entitled to one free credit report per year from a participating credit bureau: Experian, TransUnion, and Equifax. I recommend requesting a credit report from each of these, as the numbers may vary between bureaus.

This often shocks consumers; yet each bureau assesses different factors when calculating creditworthiness. The numbers aren’t likely to vary too severely, but their differences can give you insight into the “range” your credit score fits into.

Simply navigate to the website of each credit bureau and submit your request for your credit report. Many credit card companies now offer users access to their FICO credit scores via their online accounts, but these are not equivalent to full reports—full reports display all existing debt, credit utilization, and factors influencing scores.

Once you receive your reports, go through them thoroughly and be on the lookout for errors. Believe it or not, credit report errors are very common and fixing them can offer a quick and easy credit fix in the moment. If you do discover an error, file a dispute with the bureau immediately.

Your credit report will also provide insight into what’s influencing that score, which often falls on a spectrum of 300 to 800+. Each credit bureau uses a slightly different scale, but in general, an excellent credit score is at least 750; a “good” score lies between 700 and 749, and “fair” is between 650 and 699. View this chart here for more information.

Factors that influence your score include your debt-to-income ratio, credit utilization, missed or late payments, and length of credit history. I’ll discuss these at length below.

Assess Debt-to-Income Ratio and Credit Utilization

With your credit report in hand, now is the time to analyze your debt-to-income ratio and credit utilization.

Your debt-to-income ratio is exactly what it sounds like: the ratio of your current debt to your current income. I recommend calculating this on a monthly basis, as in the following example.

If you have a total monthly debt of approximately $1,500 and your monthly income is at $5,000, your debt-to-income ratio is 1,500:5,000, which equates to a 30% ratio.

Prospective homebuyers can qualify for a conventional mortgage provided they have a debt-to-income ratio of less than 46%. I recommend striving to maintain a ratio of 30-36%.

Often this ratio hinges on your credit utilization, which refers to how much of your current credit lines you are actually using. If one of your credit cards has a credit limit of $5,000, for example, and your balance is currently $1,000, your credit utilization is 20%.

In general, higher credit utilization can negatively influence credit scores, particularly if you consistently struggle to pay off credit card balances. Aim to keep your credit utilization at 30% or lower per account in order to do your credit score a favor.

Catch Up on Payments

Missed or late account payments can dock valuable points from your credit score. Even if you’ve been forced to carry credit card balances for quite some time, do your best to pay the minimum required payment on its due date (or before!) every single month.

Catching up on payments can also save you extensive late fees, which can quickly add up.

If you’re struggling to make even the minimum payment on your current account balances, consider changing payment due dates to better accommodate your income flow. For example, it may be wise to schedule payments a few days after a direct deposit rather than a few days before, when you’re more likely to be low on cash.

You may also be able to contact credit card or loan companies and negotiate lower monthly payments, depending on the debt you are trying to manage.

Debt consolidation is another option for ameliorating consistently missed payments—and a consequently low credit score. Debt consolidation often entails taking out a personal loan equal to your current debt, paying those accounts off, and then making one singular monthly payment to your new lender.

This can be valuable for individuals who are weary of accumulating credit card debt, fees, and sporadic monthly payments, particularly if these monthly obligations come attached to high interest rates.

Lastly, you may qualify for debt relief. Learn more here.

Consider Credit History

Seven years may seem like a long time, but in credit score speak, that’s pretty slim for credit history. Credit history refers to the length of time you’ve been an active borrower, and slimmer credit history can actually impact your score.

There’s no in-the-moment fix for thin history, save for the possibility of co-signing on a conventional mortgage with an individual who has a more robust history. In many cases, homebuyers finance houses with spouses or domestic partners; others bring in mom or dad, a relative, or even a business partner.

If you do opt for a co-signer, make sure you ask for their permission first. Co-signing is no small commitment, especially because it requires the co-signer to manage loan payments if you default.

Credit score knowledge is a boon for every future homeowner. If you still want to learn more about getting your credit score in shape for a mortgage application, I recommend spending time on a site like Credit Karma, which has great (free!) tools for credit management.

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Kate King

Kate King is a freelance writer, editor, and blogger. 

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