—Buying & Selling

Preparing Your Credit to Buy A Home

Getting your finances in order before beginning your home search is so important for a number of reasons. First, it helps you understand what you can really afford. Second, it allows you to get pre-approval for a mortgage. Third, and most important, it greatly decreases the chance of something unexpectedly coming up that causes your home buying plans to fall through.

A key component to organizing your finances is looking into your credit. While you need to evaluate your savings and your budget for the down payment, lenders will closely scrutinize your credit before offering up a loan. So, don’t forget about it when you’re preparing to buy a home.

Where credit factors in for lenders

Applying for a home loan usually means asking for a large sum of money. The only way to get approval for that mountain of cash is to convince the lender you’ll have the resources to pay them back. Whether this is over 30 years or sooner, your credit score helps determine the likelihood that you’ll stay on top of your mortgage payments.

Your credit history shows lenders how well you do paying your debts, whether you’ve missed a payment or ever defaulted on a loan. Your credit also shows them how much outstanding debt you currently have, which is important when assessing how much more you can handle.

In addition to your credit history, lenders may look at other key aspects of your financial situation, including:

  • Credit score
  • Available down payment amount and desired loan amount
  • Income and work history
  • Tax returns
  • Bank statements

Although just one piece of your financial puzzle, your credit provides lenders with a lot of information. It can weigh heavily on whether you secure a loan, so make sure it’s in tiptop shape before the house hunting begins.

The ideal credit score

Different types of home loans have different minimums when it comes to credit scores. The good news is, the average FICO credit score in America is 695, well above the minimum for a conventional loan, the most popular option. This is the standard type of mortgage, where you come to the table with a down payment and take out a loan for the rest of the price of the home. The minimum credit score is 620.

For those needing a loan option with a little wiggle room when it comes to credit, an FHA loan has much lower credit score options with one caveat. FHA loans have requirements for how much money you put down as well.

  • With a minimum credit score of 500, and 10 percent down, you can get an FHA loan.
  • With a minimum credit score of 580, and 3.5 percent down you can also qualify for an FHA loan.

With variations in what an ideal credit score is to buy property, you don’t have to rule out homeownership if your credit history isn’t great, or your score is on the lower end. You also don’t have to accept your credit score as is. With enough forethought, you can give yourself time to raise your score before you begin applying for mortgages.

How to improve your credit

If you’re considering buying a home, it’s ideal to check your credit between six months and a year before you start the process of applying for a mortgage. This gives you a big enough window to work toward raising your score if it’s on the lower side.

While there aren’t any guaranteed ways to bring that credit score up, there are some methods that may add a few extra points. These include:

  • Paying your bills, and doing so on time. Try not to miss any payments for any type of debt at least a year before buying a home.
  • Paying down large credit card balances. Even if you pay your credit card bill on time, the more you owe the more damage your credit score can take. Working to pay down balances by taking a few months to make larger payments can make a difference.
  • Putting a moratorium on new credit cards. Each time you apply for credit the lender pulls your credit score. Each request like this temporarily lowers your score as well.

Ideally, doing more than one of these, over the course of a few months, should give your credit score a bit of a boost.

The debt-to-income ratio

Along with your score, credit also includes your debt-to-income ratio (DTI.) This measures your outstanding debt as a percentage of your income before taxes. It’s found by adding up all your debt payments each month and dividing it by your gross monthly income.

The ideal DTI is 43 percent or less. Lenders may offer a loan for someone whose DTI is higher,  but it’s risky on both sides, and may leave you struggling to make your monthly mortgage payments.

It’s possible to lower your DTI before applying for a mortgage should you want a better chance of securing financing for a new home. You can do this by either increasing your income, or lowering your existing debt.

Strategies for lowering debt quickly include:

  • Paying off your smallest debt first to clear it out of the queue.
  • Chipping away at debt with the highest interest rates so you pay less over time.
  • Attacking your biggest monthly bill with a few months of extra payments to make a noticeable dent.

Each of these options require you to take a hard look at your finances. Concentrate on all types of debt to ensure you’re looking at the complete picture. This includes credit card balances, car loans, student loans, and personal loans. Then, do what you can to pay your debt down, enhancing your credit well in advance of adding a mortgage to your financial obligations.

Why good credit matters

Having good credit makes a significant difference beyond simply securing your initial loan. It impacts your interest rate, which in turn controls the amount of interest you’ll pay over the life of your mortgage. Considering the average mortgage is 30 years, the interest racks up.

Strong credit can save you tens of thousands of dollars over the course of your mortgage. It can also improve your interest rate by close to five percent. 

The difference between rates if your score is bad versus it being excellent is a wide gap, but even raising your score by a few points can create a dramatic difference. For example, going from a “bad” score to a “poor” score can lower your interest rate by almost three points. If your mortgage is for $190,000, that rate change can save you $134,000, over 30 years, in interest.

Credit rating infographic sundae homes

Original page source: https://credit.org/2014/01/22/what-is-a-good-credit-score-infographic/ 

Finances in order? Start the home hunt

Understanding the power your financial situation has over the home buying process is huge. It will motivate you to start early, getting everything in order to ensure you have solid credit. This foundation then makes it easier to finance a home with an interest rate that’s going to save you money over time. You’ll not only have a smoother process to buy your dream home, but you’ll secure a mortgage that rewards you for the work you’ve put into your credit.