Before we get started on the home buying process series of posts, I wanted to address something we haven’t talked about yet – your credit score. Bear with me here, this is a long post. (The TL:DR version is make sure your credit score is accurate and high for the best interest rates.) Your credit score, in case the hundreds of commercials and companies haven’t convinced you, is extremely important. Mortgage lenders use your credit score not as a way to determine if you could afford the monthly payment on a loan, but as a measure of how stable you are financially i.e. how likely you are to default on the loan. And if you have a terrible credit score? Forget it. Even with a substantial down payment (greater than 10%), a high annual income, and significant assets, a lender will probably not even consider you without a credit rating of at least 650. Most companies want to see credit scores above 700, but even in the 700-750 range, you likely be paying higher interest rates than someone who has a 760.
That’s the part that frustrates most buyers – is 760 really that different than 740? No, not really. It probably doesn’t even reflect a different risk to the company – it just puts you into a different bracket on the spreadsheet, and that’s usually how your rates are figured out.
So what negatively affects your credit? Here are some things you should avoid in the year or so before applying for a home loan:
– Not paying your bills on time. This is a big one. You shouldn’t have any late payments on any accounts in at least the year before applying for a mortgage.
– Debt to credit ratio. This is confusing to some people – it’s a measure of how much debt you have to how much available credit you have. Let’s say two people each have $10,000 of available credit, but one person has $3000 in debt and the other has $7000 in debt. The second person has a higher debt to credit ratio, which could negatively affect their score moreso than the first person.
– What kinds of accounts you have. This one can be a little confusing too. Having too many open credit cards can definitely hurt your score, but have a mix of installment loans (student loans, car loans, etc) and a couple rolling credit accounts (credit cards, usually) can actually help your credit score.
– Recent credit inquiries. As crazy as it sounds, when companies check your credit, it actually hurts your score. It’s best to avoid these credit inquiries (e.g. getting credit for a car, furniture, etc) in the year before applying for a mortgage. This is another one that mortgage companies use as a measure of how financially stable you are – if you’re taking out lots of credit, they may not see you as a financially stable person.
This is why it’s important to make sure you have excellent credit before applying, and the best way to do that is to know exactly what’s on your credit report. The government requires that you get one completely free credit report per year, which you can do at www.annualcreditreport.com. You should make sure that all of the information on your report is accurate, and dispute any inaccurate information. You can dispute anything that doesn’t look right to improve your score as much as possible.
If you have any additional questions, the Federal Reserve is a good resource, as is the Consumer Information section of the Federal Trade Commission website. Hope this helps clear up any questions you might have!
*Full disclosure: I’m not a financial adviser or an attorney, and this is not intended as individual financial or legal advice. This is intended as a summary of information from legitimate sources and is intended only as general information to a wide audience.