If you’re looking to buy a home and decide to finance it through a mortgage, it’s important to understand that your credit score will impact your ability to get one as well as what rates you’ll qualify for. Should your credit be damaged, you might be thinking there’s no way for you to achieve home ownership.
Thankfully, there are simple ways to improve your credit if you’re dedicated to making it happen and willing to be patient.
The first thing you need to understand is what the mortgage process entails and how to get approved. When you start shopping for a home, it’s important to know what price range you’ll be able to look in. Many individuals find it helpful to get prequalified or to get a home loan pre-approval before they begin shopping for a house.
While a prequalification or preapproval isn’t an official offer, it can give you an idea of what amount you’ll be approved for, the types of programs you can use, and what your rates may be. Just like they do during the actual approval process, during pre-approval a lender will look at various factors like your income, credit score, and debt-to-income ratio.
If you want to get the best deal possible for your mortgage and know your credit score is in need of help, it’s smart to start the process of repairing it before you reach the pre-approval stage of your home buying journey.
If you’re trying to improve your credit score, you have to start by understanding how credit scores are calculated and what areas to focus on, as well as the fact that you have more than one credit score and that different lenders will look at different scores.
Factors that are often used in score calculation include the length of your credit history, how many credit accounts you have open versus the age of those accounts, and how much credit you have used versus what you have available (also known as your credit utilization). Your credit scores can also be impacted by late or missed payments and how many inquiries into your credit score have been made by lenders.
According to Experian, the most important factor of your FICO credit score is your payment history, followed by the amounts you owe to creditors. After that, the length of credit, the mix of credit types, and any new credit affect how your credit is scored, though their impacts are much less significant.
Once calculated, credit score ranges are used to show whether a credit score is poor, fair, good, very good, or exceptional. While this ranking is less useful than knowing your actual credit score, it can be handy information for tracking how your credit building or repair efforts are going.
With an understanding of credit scores and how they’re used in the home buying process, you can begin to consider the best options for improving your credit. Here are five things to know.
Tip #1: Know and Monitor Your Credit Scores
There is no way to improve your credit if you don’t know what your score is or if your efforts are increasing it. Thankfully, there are many places where you can get your credit score. For example, if you currently have a credit card, at least one of your credit scores will often be included on your monthly statement.
There are also free credit monitoring services you can use, such as CreditWise and Credit Karma. It’s also important to keep in mind that these scores may not be entirely accurate in regards to what lenders see, but the scores shown on these services are a great way to keep up with changes in your scores and see where your efforts are getting you.
It’s also important to request your full credit reports. Once a year you can request your credit reports for free on AnnualCreditReport.com. The Consumer Financial Protection Bureau recommends you order from the three credit bureaus (Experian, Equifax, and TransUnion) one at a time so you can continue to monitor your credit report throughout the year.
If you’ve used all of your free reports and want to check again within the 12-month period, you can buy additional reports; federal law caps charges from the credit bureaus to $13.50 per report.
Tip #2: Pay Off Your Existing Debts
Outstanding debt is one of the most important things to manage if you want to raise your credit score. If you monitor your credit reports, you’ll have a solid idea of what you owe and to whom. You should make note of what debts are still owned by the original creditor and which have been sold to a collection agency.
Collections can have a larger impact on your credit because it allows debt to stay on your credit report for longer. If you have debts in collections and can’t afford to pay them off in full, it can be a smart idea to negotiate with debt collectors. This can include arranging for a payment plan or settling with the lender to take a partial payment.
In a settlement, the amount is usually only slightly lower than the original debt. The downside to settling is that the account won’t be removed from your credit report, but it’ll have less of an impact. Also, if you do choose to negotiate with debt collectors, always make sure to get your agreement in writing.
Snowball Method vs. Avalanche Method
For debts still with the original lender, you’ll need to decide on a debt repayment strategy. The most common strategies are known as the debt snowball and the debt avalanche method.
First, the debt snowball method requires that you look at the amounts of your debts and organize them from smallest to largest amount. Then, you start paying off all of your debts. While maintaining the minimum monthly payments on all of your other debts, you’ll focus on paying off the smallest debt by paying as much as you can every month. Once that debt is paid off, you start over with the next smallest amount and continue until they’re all paid.
Next, the debt avalanche method is similar, but you’ll organize your debts by interest rates from highest to lowest. Then, you’ll repay your debts starting with a focus on the one with the highest interest rate while maintaining all of your minimum monthly payments. When that is paid off, you move to the next highest interest rate and continue on until you’re done with payments.
Both methods have their advantages. Using the debt avalanche method is a smart move because you end up saving money on interest. However, if you’re a person who feels motivated by accomplishments, the debt snowball method could be a great fit for you as you can check items off your list sooner than with the debt avalanche method.
Tip #3: Keep Future Payments On-Time
Late payments have the largest negative impact on your credit score. If you have bad credit, then making sure future payments aren’t late is one of the most important things you can do. Many bills have an autopay option and opting into it is the best way to avoid late payments. Bills that don’t have autopay will require planning.
Start by looking at what amount you’ll need to pay each month and account for this in your monthly budget. You should also find a method of reminders that works best for you. This may involve writing them on a physical calendar or setting an alert on your phone. If you can afford it, hiring an account manager or money manager can help to ensure you don’t miss payments, as they’ll be handling them for you.
Sometimes you can’t avoid late payments. If you know you’ll be unable to pay on time, you can reach out to the provider to make a special arrangement or apply for emergency assistance. Or, if you’re already late on a payment you should try to avoid missing an entire cycle. Delinquency won’t be reported until you’re more than 29 days late. So, communicate with your lenders, try to make the payment before the lender reports to credit bureaus, and resume on-time payments as quickly as you can.
Tip #4: Consider if Debt Consolidation Is Right for You
Debt consolidation is the process of getting a new line of credit to pay off your existing debts. This typically involves getting a loan but is sometimes done using a balance transfer credit card. Many personal loans can also be used for this purpose.
You should only consider debt consolidation if it’ll take you more than a year to pay off your existing debts. This is also an option to consider if your credit is better now than when you got the other lines of credit that you’re now looking to consolidate.
Depending on your credit score, you can possibly get a lower interest rate than you got from your previous lenders, which will save you money over time. It may also allow you a lower monthly payment and help you get out of debt by allowing you to pay off the new loan faster.
Consolidation can also reduce your credit utilization and allow you to have on-time payments reported to credit bureaus, thus raising your credit score. The flip side is that some loans may come with additional fees (such as loan origination fees). You could also risk a higher interest rate if your credit is worse than it was when you took out the old loans or damage your credit score further if you miss payments on the new loan.
Tip #5: Build on a Thin Credit File
The reason why the age of your credit accounts affects your score is that lenders prefer to provide loans to borrowers with a proven history of paying their debts back on time. If you have limited or no credit history, or have a report that shows major delinquency, a secured credit card can be a good option for you. When people think of credit cards, they typically picture what is known as an unsecured card. A secured card is where a lender gives you a line of credit based on your perceived creditworthiness.
An unsecured card works similarly in that it allows you to buy things now and pay for them later over time. However, secured cards require you to make an initial deposit from a checking account. Typically your credit limit for these cards is equal to the amount of the deposit that you make. The lender will hold this deposit in an account, such as a certificate of deposit, as collateral.
If you fall behind on payments, the lender will take the deposit and close the account. This reduces the risk for the lender, and because of that, the approval requirements for these cards are much less strict. When the account the deposit is in matures, you’ll get your deposit back. Oftentimes, at this point, the lender will allow you to upgrade to an unsecured card based on your payment history, credit score, and income at that time.
Your credit score is an important factor in large purchases that require loans, especially when you’re trying to buy a house. If your credit is damaged, it can feel like getting a mortgage is forever out of reach. Thankfully, with some work and some time, you can repair your credit and get approved for a mortgage that will allow you to buy your dream home.