You found it. Your dream home with a white picket fence and window boxes, or with a home theater and infinity pool. You go to your local bank and proudly declare, “I need a mortgage, sir!” He smiles, nods, and hands you the keys to your new home.
This is certainly the right time to buy a dream home. in your dreamsbut this is far from reality. Lenders don’t just hand out wads of cash to every potential home buyer; they hand out stacks of documents. They do their due diligence and make sure borrowers are prepared to handle the huge responsibility of owning a home and paying for it.
There are several ways lenders evaluate your financial ability to keep up with a mortgage, and one of the key details they consider is your credit history. In fact, this small number can either increase or destroy your chances of becoming a homeowner.
What credit score do you need to buy a house?
According to Experian, Most mortgages require a credit score of 620 or higherbut no Everybody them. In fact, depending on the type of loan you are pursuing, your credit score may be in the 500 range. But that doesn’t always mean that you should borrow money.
Because a credit score indicates a borrower’s risk (or lack of it), lenders will spread their higher rates to borrowers with lower scores. With that in mind, even though you maybe buy a home with a credit score of, say, 540, borrowers with a higher score, say, 740, will be the ones who walk away with better deals.
When lenders work with buyers with low credit scores, they find ways to mitigate this risk. For example, you are likely to pay a higher rate and possibly even a larger down payment. In other words, they need to cover their asses in case you can’t pay, which, based on your low credit score, is entirely possible.
Read more: What credit score do I need to buy a house
How can you get a loan in preparation for buying a home?
If you are just starting to build up your credit or are trying to build up your credit backThere are several ways to improve your credit score and, as a result, your chances of buying your dream home.
Apply for a credit card
One of the best ways to get credit is to get one or more credit cards.
If you’re stuck with the phrase “one or more”, I’m sorry to inform you that there really isn’t a single agreed number of cards you should receive. According to Experian Consumer Credit Review 2019, the average American has four credit cards. However, while you can certainly have multiple cards and still maintain a solid credit score, for some people, two is too much!
Read more: Do you have too many cards?
Minimize credit requests
While the number of credit cards you have is less important than how you use them, applying for multiple cards at the same time will not help your credit history.
When you apply for a credit card, it is a hard call on your credit report and will usually deduct five (or more) points from your score. Therefore, if you apply for multiple credit cards at the same time, it can significantly impact your score and may signal to the lender that you are at high risk.
Instead of applying for multiple credit cards to find out which ones you qualify for, do your research and use online pre-qualification forms (soft questions).
Read more: Soft traction vs. hard traction – how each affects your credit
Pay bills on time
This advice is a no-brainer, especially considering the fact that “payment history” is the biggest factor (35%) affecting your overall credit score!
While applying for multiple credit cards at the same time can lower your score by a few points at a time, late payment can reduce 100 points or more! (Credit bureaus report late payments if they are 30 or more days past due.) Meanwhile, timely payments will have the opposite effect, gradually increasing your score over time.
Keep balances low and cards open
Another way to increase your credit is to keep your balance low. Experts advise avoiding using more than 30% of the available credit, which is called the credit utilization ratio. For example, if your credit limit is $1,000, it is recommended that you spend no more than $300. In fact, you should probably spend a lot less if you have the ability, and if you have debts, pay them off ASAP!
Also, even if you stop spending money on your credit card altogether, you should keep it open.especially if it’s an old card. The reason for this advice is that your old cards mark the beginning of your credit history and lenders want to see an established credit profile. In addition, closing the card will reduce the amount of available credit and, as a result, may increase the credit utilization rate above 30%.
Read more: When, if ever, to cancel a credit card
Check your credit report for errors
Finally, it is important to check your credit profile for errors from time to time.
Each year you are provided with one free copy of your credit report from each of the major credit bureaus – Experian, Equifax and TransUnion. Take advantage of this offer and make sure these records accurately track your credit history. If you find something wrong, such as a missed payment that you actually made, contact the bureau to correct the mistake.
Scanning these reports for errors can lead to an immediate boost in your credit score!
Pay off delinquent accounts
While checking your credit report for errors you may find some old accounts that you haven’t been paying. Maybe you forgot about them — or maybe you didn’t — but either way, getting these delinquent accounts paid off can go a long way toward raising your credit score.
The newer models of credit (FICO 9) ignore accounts that have been in collections but have zero-dollar balances. But even if your lender is using the older model (FICO 8) paid off balances look better than outstanding delinquent accounts.
Use your bill payments to build credit
Did you know you can actually get credit for paying your bills on time? Typically, paying your bills, such as rent, electric bill, Netflix, cell phone, etc, won’t do anything to build your credit score but Experian has a free service that solves that.
To use Experian Boost you simply sign up, link the bank accounts you pay your bills from, and let Experian know which bills you want it to track.
Once you are signed up, paying those bills on time will begin to improve your credit.
Check out our full review of Experian Boost here.
What other factors do lenders consider to determine your borrowing eligibility?
Your credit history is crucial when it comes to home-buying potential, but mortgage lenders evaluate a lot more to determine whether or not you’ll be a reliable borrower.
Here is a short list of the most common financial factors lenders consider (the specific qualifications required for each of the following categories depends on the type of loan):
- Income: lenders want to see that you’re making enough money to afford your monthly mortgage payments.
- Employment history: lenders typically look for steady income, often in the same job/industry over the last two years.
- Tax returns: generally for the last two years.
- Debt-to-income ratio: this measures how much of your income is used to pay off debt; lenders typically want your total monthly debts to be no greater than 43% of your gross monthly income.
- Savings balance: lenders typically look for enough savings to cover two months’ worth of mortgage payments.
Can I still get a loan if I don’t meet the credit profile qualifications?
While it is possible to qualify for a mortgage loan with bad credit, you’ll need something else to win lenders over…like cash. Lenders want to know you can afford to take on such a significant financial burden, and if you come to the table ready to put down a hefty down payment, you’ll have their attention.
For example, if you want an FHA loan through Rocket Mortgage by Quicken Loans, you would need a credit score of 580 or higher and a minimum of a 3.5% down payment. However, if you’re able to afford a 10% down payment, you could qualify with a credit score of just 500! Or, if you have poor credit but also have a healthy debt-to-income ratio, you could qualify for some government-backed loans through Rocket Mortgage.
Keep in mind lenders are evaluating much more than your credit history, and every lender will weigh categories differently.
Summary
A good credit score can take years to establish, so it’s important to start building up your credit long before your dream home presents itself.
While there are some government-backed loans, like FHA and VA loans, available for borrowers with poor credit, they come with some cons as well, like high-interest payments.
So, start building credit as soon as you can!
