Anyone who is looking for a loan to buy a home or refinance their mortgage, should keep a very close eye on their credit. Your credit report and credit score are two very important factors used by mortgage lenders to ascertain whether you can qualify for a mortgage or not.
If you have a great credit profile, you will get a great mortgage with a good interest rate and terms that can save you thousands of dollars. On the flip side, OK or bad credit with a lower credit score will most likely result in a less favorable loan that may also cost you thousands of dollars in the long run, or you may even be turned down for a mortgage altogether. Hence, your credit should never be taken lightly.
Here are 5 things you should do with your credit before you apply for a mortgage;
1. Get a Copy of Your Credit Report and Try to Understand How Your Credit Score Works
In order to avoid any credit complications when applying for a new home loan, it is best that you review your credit first to find any problems and/or errors so that you can fix them before you talk with a lender. Therefore, one of the first things you should do is pull your own credit report.
You do not need to pay for your credit report because the Fair Credit Reporting Act (FCRA) requires each of the nationwide consumer reporting companies — Equifax, Experian, and TransUnion — to provide you with a free copy of your credit report, at your request, once every 12 months, according to the FTC.
The three nationwide consumer reporting companies have set up a central website, a toll-free telephone number, and a mailing address through which you can order your free annual report. To order, visit http://www.annualcreditreport.com, call 1-877-322-8228, or complete the Annual Credit Report Request Form and mail it to: Annual Credit Report Request Service, P.O. Box 105281, Atlanta, GA 30348-5281. Do not contact the three nationwide consumer reporting companies individually.
Once you get a copy of your credit, you can then review your credit for any issues and/or mistakes that you can correct. About 90% of top mortgage lenders will use your credit score and report when they are making major decisions on whether to extend you a mortgage or not. If you want to effectively raise your credit score, you will first have to understand how it is calculated so that you do not miss out on very useful information that might help you improve your credit score.
Among the important things you should understand about your credit score is how data in your credit report is broken down. You should note that the data in your credit report breaks down into five main categories which are as follows; Payment history: 35 percent, Credit history Length: 15 percent, Types of credit used: 10 percent, Amounts owed: 30 percent, and New credit: 10 percent.
An additional 30% of one’s score relates to the total amount of credit that you are using. Getting your credit card balances down to 20-30% of your credit limits is a wise spending decision too.
Here is the FICO scale to help determine where your credit currently stands:
800 – 850 Excellent Credit
740 – 800 Great Credit
700 – 740 Good Credit (Average)
600 – 700 Okay Credit
500 – 600 Poor Credit
300 – 500 Bad Credit
2. Correct Any Errors
A 2013 Federal Trade Commission report found that 25% of all reports contain some kind of error that could affect a credit score. The FTC report also found that 5% of Americans saw their credit scores improve by over 25% when the errors were corrected.
I would like to first warn you that you should dispute and correct any errors prior to applying for a new home loan because all it takes is one disputed account under investigation by the credit bureau to delay or, in some cases, kill your chances of obtaining a new mortgage.
Once you have a copy of your credit report, you should work on correcting and/or disputing any errors in order to raise your credit score. If you do happen to find any errors, you must notify the credit reporting agency in writing and include any other necessary paperwork that proves the reporting was an error.
In your letter, you will need to make a list of all errors you have found and clearly explain why you believe the information is incorrect. Once the point has been made, you must politely request that they are removed. It will be beneficial for you to include an entire copy of your credit report with the errors highlighted or circled.
Make sure you send it by certified mail with a return receipt requested so you can keep track on when it is received. Document when the letter is sent and when it is received by the agency if needed be.
The credit agencies have 30 days to glance at the errors and get back to you. It is required for them to forward all the information they received from you about the potential errors to the company who gave them your information. Once the company receives your information, a formal investigation must be made to decide whether or not your errors were reported accurately.
When it is determined that an error was made on your credit, the reporting company must report back to the major national credit agencies so that the mistake on your credit may be removed.
3. Pay Your Debts On Time
Paying your debts on schedule will stabilize and even improve your credit over time. Payment histories make up 35% of anyone’s total credit score.
One of the last things you want to do before applying for a new mortgage is to have a late payment on any of your current debt that you pay monthly. This means that when you have a monthly payment due on a credit card or even your cell phone, pay it off as quickly as possible no matter how big or small it is. Setting up automated payments and reminders is one way of doing this.
4. Analyze Your Current Debt to Income Ratio
Besides your credit scores, the amount of income you make monthly and your monthly payments for debts is a key factor that lenders will examine in order to determine what your current debt to income ratios are. A mortgage lender will simply add up your current debts on your credit report and then subtract it from your monthly gross income in order to come up with a ratio.
If your ratio is too high, then you will not be able to qualify. If your ratio is low, that is a good thing and means that you can afford a mortgage payment, real estate taxes, and homeowners insurance.
The standard debt to income ratio should be around 36% to as high as 43%. The Consumer Financial Protection Bureau says that 43% is generally the highest debt-to-income ratio a consumer can have while still being eligible for a Qualified Mortgage.
If you find that you have too many debts and your debt to income ratio is too high to qualify for a mortgage, then it may be a good idea to pay off some of these debts in order to bring your ratios down to an acceptable level. Consolidating some of your debt may also help your debt to income ratios.
Your goal should be to have the lowest debt ratio possible because this means that you will have more money and less debt which is always a good thing.
5. Do Not Open and Close Accounts and Do Not Max Out Credit Cards
When you are trying to improve your credit score prior to applying for a mortgage, it is not a good idea to open any new credit accounts and close accounts because it can negatively affect your credit score.
For example, some first-time homebuyers make the huge mistake of buying tens of thousands of dollars on furniture, kitchenware and other household amenities on credit before the mortgage is approved. This may cause your debt to income ratios to rise to unacceptable levels and your credit scores may drop so that you can no longer qualify for a mortgage.
Maxing out just one credit card can cause your FICO score to drop by as much as 45 points and disqualify you from getting a home loan.
One Last Tip
Your lender will pull your credit at any time up to the closing of your mortgage to see if you have applied for any new credit and/or if your scores have changed. It is crucial that once you began the application process, that you do everything in your power to keep your credit the same and to not apply for new credit and/or close any accounts.
Any changes can potentially alter your loan terms and/or disqualify you altogether. If you have things you want to buy on credit or accounts you would like to close, just wait until after you close your loan.