5 Ways to Improve Your Credit Score Before Buying a Home
Every homebuyer is hoping to get approved for a mortgage at the current, historically low rates, but experts warn that only people who have high credit scores are likely to receive them.
Lenders use your credit score to help them determine the likelihood of you repaying a mortgage loan with on-time payments, said Jackie Boies, a senior director of housing and bankruptcy services for Money Management International, a Sugar Land, Texas-based nonprofit debt counseling organization. A mortgage lender will examine your credit reports from all three of the nation's main credit reporting companies – Equifax, Experian, and TransUnion – and take a deep dive into the details to see if there are indications you might default on your home loan, she said.
A higher credit score yields homebuyers a lower interest rate, helping them save thousands of dollars during the time they have the mortgage, which could be up to 30 years. Checking for mistakes and paying off debt can increase your credit score, she said.
“The best rates go to the applicants with the best credit, but the threshold for ‘best credit’ is higher on mortgages, typically above 740 or 760,” said Greg McBride, chief financial analyst at Bankrate, a financial data company. “Getting a rate that is half of a percentage point higher than what could have been obtained with a better credit score can cost nearly $70 per month on a $250,000 mortgage.”
Buying a home can be nerve-wracking, but there are several ways you can boost your credit score before you start shopping for a mortgage. Keep in mind that it can take several months before an improvement appears on your report.
Here are five ways to improve your credit score before you purchase a home.
1. Pay Your Bills On Time
Your credit score consists of three major factors and one of them is paying your bills on time.
“The low hanging fruit of a good credit score is paying your bills on time – it makes up 35% of your score,” McBride said.
Using tools like autopay can help you pay your bills on time – month after month, year after year.
2. Lower the Amount of Debt You Owe
The amount of debt you owe compared to what is offered to you is called credit utilization. Avoid charging near the maximum amount on your credit card since the amount of credit you use makes up 30% of your credit score.
“Together, nearly two-thirds of your score is showing a demonstrated track record of paying bills on time and responsibly managing your debts, particularly revolving debt,” McBride said. “One step that can have quick results is to pay off or pay down revolving debt such as credit card balances – just do so without compromising your home down payment fund.”
Focus on paying down credit cards with low credit limits, said Leslie Tayne, a Melville, N.Y. attorney specializing in debt relief.
“Using a high amount of your credit limit negatively affects your utilization ratio, lowering your score,” she said.
3. Use Different Types of Debt
Lenders prefer to see consumers have a good credit history and also that consumers can pay off different types of debt on time. About 15% of your credit score will be based on the length of your credit score, which includes the age of your oldest credit account, newest credit account, and the average of all accounts, Boies said.
The type of debt you owe will make up another 10%. A combination of different kinds of debt such as an auto loan, credit card, student loan, mortgage, and other installment loans will positively impact your credit score, she said.
4. Avoid Making Large Purchases
The remaining 10% will be based on the number of credit accounts you've recently opened, plus the number of hard inquiries lenders make when you apply for credit. Avoid making a major purchase such as a car in the months before you apply for a mortgage because having an auto loan also increases the amount of debt you owe compared to your income.
“Too many inquired and recent accounts can negatively impact your credit score,” Boies said. “Mortgage lenders use credit scores that are tailored to more mortgage-relevant factors, much as auto lenders use scores that are based on more auto loan relevant factors. How a current or previous mortgage was handled, plus big picture factors like debt ratio, timely payments, and recent credit inquiries are more impactful when applying for a mortgage.”
Obtaining other types of debt such as a new credit card before you obtain a mortgage is also frowned upon, Tayne said.
The mortgage underwriting process is a lot more involved than obtaining an auto loan but includes many of the same credit factors, she said.
“While it might not be a big deal to apply for credit cards before seeking a new car, even slight drops in your score can cost you quite a bit over a 30-year mortgage if you have to pay a higher interest rate,” Tayne said. “During the mortgage process, your debt-to-income ratio is also more heavily scrutinized and you might be questioned about expenses and all sources of income.”
5. Keeping Cash On Hand
It helps to have cash on hand in checking and savings accounts at the time you are applying for a mortgage, said Bruce McClary, spokesperson for the National Foundation for Credit Counseling, a Washington D.C.-based nonprofit organization.
“While it can help to have liquid assets that can be applied towards your down payment, income and asset stability is another way of demonstrating your capacity to repay the loan,” he said.
Mortgage lenders take a much closer look at your credit report and history and blemishes on your credit report are more impactful when applying for a mortgage than when purchasing a vehicle or obtaining a personal loan. Auto lenders are able to overlook some issues since their risk is not as great and are examining the likelihood of a borrower becoming delinquent within the first 24 months of purchasing a vehicle.
On the other hand, mortgage lenders also look for what is known as “seasoning” or the length of time a down payment has been in a savings account. If a family member is providing a portion of the money toward your down payment and closing costs, the funds should be there at least 60 days before you apply for a mortgage.
“Your lender is looking to confirm that those funds have been in your bank account for at least the last 60 days,” Boies said. “You’ll just need to have the funds deposited into your bank account and then time your loan application appropriately.”
Errors on your credit report are not unusual. It’s important to review your credit reports from all credit reporting agencies each year, especially before you apply for a mortgage, Boies said. You can obtain them for free at www.annualcreditreport.com and dispute any errors you find on the report.
“There are many steps to becoming a homeowner and having a good understanding of the process will make for a better experience,” said Boies.
Once you’ve decided to become a homeowner, talk with a housing counseling agency approved by the Department of Housing and Urban Development to ensure you are informed and well prepared in advance, she said. HUD-approved housing counselors are listed on HUD's website and can be searched by state.
Ellen Chang is a Houston-based freelance journalist who writes articles for U.S. News & World Report. Chang previously covered investing, retirement and personal finance for TheStreet. She focuses her articles on stocks, personal finance, energy and cybersecurity. Her byline has appeared in national business publications, including USA Today, CBS News, Yahoo Finance MSN Money, Bankrate, Kiplinger and Fox Business. Follow her on Twitter at @ellenychang and Instagram at @ellenyinchang.