Analyzing your credit is possibly the most important step you can take before you start house hunting. It will determine your ability to get approved, how much you can afford and your mortgage rate.
Credit. You hear about it all the time, but do you really understand it and how it affects your ability to buy a home? Analyzing your credit is possibly the most important step you can take before you start house hunting. Your credit will determine your ability to get approved for financing, how much house you can afford and your mortgage rate. Just know the overall health of your credit is much more important (and less confusing) than credit scores.
It will help to understand your credit reports, the terms involved and the reasons that you can get so many different scores. Your credit reports are detailed histories of the types of credit you have used, the dates of your transactions, the balances and limits of any lines of credit. The reports record your payment history, any accounts that have gone into collections, information regarding bankruptcies, tax liens or court judgments.
Credit agencies, reports and scores
The three credit reporting agencies are Equifax, Experian and TransUnion. Your score for each of these reports comes from a software analysis of all the things mentioned above. Scores will typically range between 300 and 850.
Here’s where it gets tricky. While you will often hear about your “FICO score,” which is the score given by the Fair Isaac Corporation’s software, each of the three bureaus use different software to determine your score. Many major banks and credit cards have their own proprietary software as well. Your scores will vary on the version of the FICO software or other software being used. Plus, if you pay for credit reports, those scores most likely won’t match the scores lenders get, according to Consumer Reports.
This means that while your credit scores are important, you can expect to get different scores from different bureaus, reports and lenders. Therefore, the best way to analyze and improve your credit is to look at the overall story it tells – your credit report rather than the scores.
In general, the breakdown of your credit history is:
- 35 percent – payments made on time
- 30 percent – outstanding debt in proportion to available credit
- 15 percent – the length of time you’ve had credit
- 10 percent – the types of credit you use
- 10 percent – new credit (credit inquiries and accounts opened)
Reviewing your credit periodically is like getting a physical from the doctor. It is recommended that you do it annually, yet if you have reason to be concerned, then more checks are warranted. You will want to know the state of your credit if you are thinking about buying anything that requires a loan in the next year.
A study from the Federal Trade Commission (FTC) showed that 5 percent of people found errors on their credit reports. Four of every five who filed a dispute got a credit modification. So, the FTC recommends that you monitor your credit regularly. Prospective employers and insurance companies may use your credit history to evaluate you in many states.
How to improve your credit
Your timely payment history is the single most important component of your credit. Make sure all of your monthly payments are made on time, including your rent and utilities. You might consider enrolling in an auto-pay option. In the event that you make a payment late, or miss a payment entirely, contact the billing agency and ask that it not be reported. You may often get late fees waived in the same conversation.
Additionally, contact any lenders of agencies of any past-due accounts you find on your credit report. Sometimes accounts are not submitted to collection agencies, yet the past-due amounts are on your credit report.
Lowering your debt is the next step to improving credit, after you begin the process to rectify issues and errors. Lowering your balances on credit lines will improve your credit, as long as you keep the accounts open. Likewise, charging items to a credit card and then paying the balance monthly is also a good strategy for improving your credit.
Build your credit history
It is possible that you need more lines of credit to boost your scores. No credit history or a young credit history will both result in denials on mortgage applications. You may need to build your credit history with secured credit cards or lines of credit. You may also establish credit with rent payments, small loans or by reporting payments yourself.
Mortgage experts say there are a handful of mistakes you can make once you are approved for a mortgage, or start the home loan application process, that are equally as damaging as bad credit. Mistakes that top the list include:
- Paying off or closing credit cards
- Buying new assets
- Changing jobs (even for a higher-paying one)
Talk to your mortgage lender before you make changes that may affect your credit. If you don’t have a lender yet, ask your real estate agent to refer you to a lender that will help you get started. Typically, your agent will know lenders who commonly help homebuyers get their credit in order before house hunting. Plus, most agents know the dos and don’ts of mortgage credit preparation. Connect with local agents now.