By Mitch Mitchell – MORTGAGE SENSE – JANUARY 20, 2021
If 2021 is the year you’re going to make the leap to becoming a first-time home buyer, we’re rooting for you. But before you go out and start house-hunting, remember that the initial step is to get pre-approved for a home loan. To do that, you’ll want to get a handle on your credit history and credit score. The key factors that make up a credit score are:
- payment history
- the total amount owed
- length of credit history
- types of credit in use
- new credit accounts
If your credit is less than perfect, non-existent, or otherwise holding you back, it may be time to consider some ways to increase your score so that you can begin the process of buying your first home. Improving a credit score to buy a house takes time, effort, and focus. To help, we pulled together five tips on how to improve your credit score before you apply for a home loan.
1. No credit is no good
Sometimes a lower credit score is given simply because a person has no credit history to base a score on. Some people simply are adamant that it’s not a good practice to borrow money. While that’s rare in this day and age, it is possible. If you haven’t borrowed any money for a student or car loan and you haven’t opened any credit card accounts, there’s no history to make up your credit report at all.
Having no credit can make a lender hesitant to work with you. If you’re hoping to qualify for a mortgage down the road, you’ll want to rectify that sooner rather than later. Open a credit card or two and make a few purchases on those cards so that you start building a record of using credit and paying it back on time. Over time, being diligent with payments on those cards can show a potential lender that you are a responsible borrower and a good prospect for a home loan.
2. Be smart about credit
Being responsible for using existing credit is the best way to improve your credit score. For example, if you have a charge card for a retailer or a bank card that offers future travel points, use it on repeatable purchases like groceries or gas for the car. Keeping the balances low and consistently paying off those purchases every month will create a history of responsible credit behavior that will go a long way towards improving your credit score.
Aiming to use no more than 10% of your allotted credit line is also a good rule of thumb. It shows that you won’t misuse your credit and fall into debt. Also, keep in mind that maxing out a credit card can hurt your score even if you pay it off in full every month. This is even true on a card with a low credit limit, so know the credit limits on each account you have.
3. Make a plan to reduce debt (or better yet, eliminate it)
It doesn’t take long for a little bit of debt to become a serious long-term problem. Paying for something like a vacation with revolving debt — like the kind you get with many credit cards — can take years to pay off and damage your credit score. That’s not something you want on your credit report if you’re looking to buy a home. What’s needed is a concerted effort to reduce or eliminate debt.
Many people drowning in debt try increasing monthly minimum payments by just a bit across all their accounts, but that barely moves the needle. Instead, it might be better to tackle the problem by focusing on one account at a time. If you make a significantly bigger payment to only one account each month until that debt is completely repaid — while still making the minimum payment on all other accounts — you’ll notice the debt shave off more substantially. When one is paid off, leave it be (remember, don’t close it) and rinse and repeat with your next account. Keep it up until all your debt is paid down.
4. Look for lower interest rates
Another thing you can do to reduce debt is to ask for a lower interest rate. The chances are that you opened a charge card account or bought a car when interest rates were higher. Because so much of a monthly payment goes towards the interest charge and not the actual balance, higher interest rates keep you in debt longer. It’s a well-kept secret, but some lenders can and will renegotiate interest rates. Just be forewarned: customers who’ve paid on time every month are more likely to cut a deal on getting a lower rate.
It also pays to keep an eye out for promotions offering lower interest rates. Balance transfers (from one card or one bank to another) can often get you a lower rate, but be cautious: promotional rates often have expiration dates. Try to pay off any balances before the promotional period ends or you may be subject to higher interest rates after that.
5. Don’t close accounts in good standing
If you have outstanding balances on credit cards, car loans, or student debt — but they’re in good standing and you’ve been making your monthly payments — keep at it. Regular, on-time payments are the solid foundation for a great credit score. But if you’re thinking of paying off a balance entirely and closing down an account, hold that thought for a second.
Credit bureaus — the businesses that create credit reports — love when borrowers have zero-balance accounts. It shows that even though you have credit available, you’re responsible enough not to use it. While getting rid of an account may sound like a good idea, it could actually hurt your credit score. Keeping an active account open with no balance looks better than having a closed account. Wait until after you close on your new home to cut up any charge cards you no longer need.
Ready to improve your credit score this year?
There are many great federal financing programs available for first-time homebuyers, including FHA, VA, and USDA loans. Plus, you might want to look into conventional mortgages from Fannie Mae and Freddie Mac or home renovation loans. Many U.S. states and cities also offer first-time buyer programs and grants for a down payment, financing, and closing cost assistance.
When it comes to applying to be pre-approved for a home loan, it pays to lay the groundwork with a good credit score. Contact a loan officer in your area to learn what else you’ll need to prepare for and to discuss which program might be right for you.
Deborah Kerr - Metuchen Real Estate Agent 