Perhaps the most critical piece of buying a home is having your finances in order. Most people require a loan to afford a home. Qualifying for a loan at the best rate means that you have to have good credit, which takes time to build. So preparing for home ownership actually starts long before you tour homes for sale.
Your credit score is one of the key items of your personal finances a bank will look at to consider your application for a loan. The credit score is formulated using five factors, in order of importance: payment history, amount of debt, length of credit, new credit, and credit mix. Each of these factors can raise or lower your score. While there is no number set in stone for receiving a loan (each bank has their own standards) the lowest qualifying numbers are in the low 600s for conventional loans and mid- to upper 500s for FHA loans. Bear in mind that banks use other factors such as job history and current debt to approve or reject a loan.
If you’re planning to improve your credit score with home ownership in mind, here are some guidelines to help you get there.
1. Keep tabs on your credit. The Annual Credit Report website (www.annualcreditreport.com) is where you should go to get a free copy of your credit report from the three major credit reporting companies: Experian, TransUnion, and Equifax. You can stagger the three reports over the year and get each for free without any affect on your credit. There is a fee for getting your credit score. Beware of free credit score sites. Although they advertise getting your score for free, usually you must give personal information to sign up, with strings attached that may cost you money down the line.
2. Fix credit reporting errors. Examine your credit reports in detail, ensuring that new credit cards opened, debt amounts, or late payment information is accurate. People have failed to receive mortgage loans because of credit reporting mistakes that were no fault of their own. When you spot a mistake, the Annual Credit Report website has step-by-step guides on how to file a claim on any of the credit bureau websites and your report itself will also have instructions. Follow them closely and keep a good record of your dispute, including copies of any documents you file with the bureaus. Once you make a claim, you should get a response within thirty to sixty days.
3. Pay your bills on time. It sounds obvious, but if you’re trying to improve your score, you must pay bills on time. Even one late payment affects your score.
4. Pay bills before they are sent to collections, then pay bills that are in collections. If you’re a month or two behind payment on utilities or credit cards, try to get those paid before month three. That way they’re unlikely to be sent to collections. If you have bills that are in the collections process, work on those next within the creditor’s agreed upon terms so that the process doesn’t start over again and remain on your account another seven years.
5. Pay more than the minimum payment. A credit history of making only minimum payments is not a great indicator of financial stability. Even if you can only pay a little bit over the minimum on your bills each month, it helps improve credit and also reduces the amount of interest you accrue on your balance.
6. Maintain a low balance on credit cards. One tip for managing your credit card debt is to not exceed fifty percent of your available limit. Pay your debts before accruing a higher balance.
7. Avoid shifting debt from one card to another. Rather than playing the shift credit card game, try to pay off debt from each card as much as you can, and stop using the card with the highest interest. Now that credit card companies have caught on to the shift strategy, they often charge hefty fees for doing so. Do the math properly and ensure the move actually saves you money before jumping into this practice. Most often you may find it’s better to get the debt paid off than paying a fee to switch cards.
8. Cut down on credit cards, but keep them open. There’s some controversy over whether to close out a card whose debt you’ve paid off. Closing a credit card can sometimes negatively “ding” your credit, especially if it’s a card you’ve had a long time. So play it safe if you’re on the credit improvement route. Reduce the number of cards you use, but don’t close accounts while working to improve credit for a house.
9. Don’t make any large purchases on credit. Buying a car or charging an expensive vacation are not the best moves when you’re trying to improve credit to buy a house. Banks don’t like to see sudden changes in your financial picture when it comes time to apply for a loan. Keep your eyes on saving and paying off current debt.
If your financial situation requires more in-depth analysis, consider turning to a credit coach service or find a do-it-yourself course online. The time it takes you to see credit improvement all depends on the reasons your credit is low. It can take months or years, depending on your situation. Understand what financial moves affect your credit the most. Discover what changes you can reasonably make in your life to establish the credit you need to make home ownership a reality.