Probably the least fun part of buying a house are those first steps. Shopping for a lender, applying for a mortgage and waiting to find out how much you can afford to spend on that new house is tedious – especially when all you really want to do is look at houses for sale.
Unfortunately, this is a task that must be taken care of upfront, before looking at what’s on the market. If your credit is ready before taking the step, you’ll be far more successful in obtaining a mortgage with an attractive rate, saving you money on your house payment.
Take the following steps as soon as you decide you’d like to buy a home.
1. Make bill payments on time
One of the worst things you can do is pay bills late or, even more disastrous, not at all. Both will impact your credit score and thus your ability to obtain a mortgage.
“Your FICO Score considers late payments using these general criteria; how recent the late payments are, how severe the late payments are, and how frequently the late payments occur,” caution the experts at myfico.com.
Don’t allow any bills to be sent to a collection agency; “… it is considered a significant event with regard to your score and will likely have a severe negative impact.”
If an unexpected financial emergency comes up, contact the creditor. Let them know your situation and ask if there is a way you can avoid a late payment on your credit.
Your payment history accounts for 35% of your FICO score, so be diligent in paying your bills.
2. Don’t apply for new credit
Keep credit card balances low and pay all credit card bills before they’re due. If you can, make additional payments to bring down the balances.
Avoid applying for a new credit card. Why? Lenders are wary of borrowers who take on additional debt and if you apply for credit, the signal that you’re sending is that you will use it and, thus, rack up additional debt.
While FICO only considers new credit applications for the past 12 months, they account for 10% of your credit score.
Consider how the reporting agencies look at credit card use:
- Age of credit–Older credit, whether cards or loans, makes the potential borrower appear less risky. New credit can ding your FICO score by as much as 10 points.
- Balances– Maxed out credit cards can cause up to a 70 point reduction on your credit score. The agencies want to see available credit.
- Lack of accounts–If you have no credit card or loans, credit agencies will wonder why.
New accounts also have an impact on “… your length of credit history.” FICO uses your “… oldest account and the average of all your accounts.” Opening a new account decreases the average age.
The exception to this rule is for the consumer with a spotty credit record. “If you can prove to lenders that you can pay your bills on time, this will help increase your score in the long run,” claim the experts.
And, by the way, credit inquiries remain on your credit record for two years.
3. Lower your debt-to-income ratio
When your mortgage application gets to the underwriter, he or she will examine your debt-to-income ratio (DTI).
Simply, this is a calculation of your income and debt that tells the underwriter how much money comes in and how much goes out every month. Borrowers with a high DTI (more than 43%) present a bigger risk to lenders.
Calculate yours with these tips from the Consumer Financial Protection Bureau. To lower your DTI, either decrease your debt, raise your income or do both. Find some additional tips on how to lower your DTI at credit.com.