In today’s tougher mortgage lending marketplace, a good credit history is essential. It used to be that you could easily qualify for a purchase home loan with low credit scores or a recent mortgage late payment, bankruptcy, or foreclosure, but not so these days. It’s a much stricter lending environment than during the heady days of the housing boom, so you need to make sure your credit report looks as good as possible.
If you have some issues with your credit, get them fixed well before you try to qualify to buy a house. The last thing you want is to get a nice home under contract then lose out on the deal because of some unexpected credit snags.
What is a Good Credit Score?
Mortgage lenders require a credit report from the three major credit bureaus ( Equifax, Experian, and TransUnion) as part of the application process to document your credit scores, how much debt you’re carrying, how maxed out your revolving accounts are, payment histories for all debt accounts, and any derogatory information such as collections, foreclosures, judgments, charge offs, bankruptcies, liens, etc.
Your credit scores are considered by lenders to be highly predictive of the likelihood you’ll default on a mortgage, so expect lenders to give them a lot of weight. When it comes to credit scores, the higher the better!
Credit score qualifications can vary somewhat depending on the type of loan you’re applying for, but the following is generally the way mortgage lenders view various credit scores:
- < 620: Bad credit
- 620 – 679: Bad to fair credit
- 680 – 699: Fair credit
- 700 – 719: Fair to good credit
- 720 – 739: Good credit
- 740 and above: Excellent credit
If you’re below 620, count on it being difficult to find a mortgage through a traditional bank. FHA guidelines allow for scores as low as 580, but most FHA lenders tend to want scores in the 620 range and above. If your scores are 740 or higher, you have excellent credit and will likely qualify for the best deals available (assuming all other qualifications are good as well).
Credit Scores Impact Rate and Fees
Credit scores have a huge impact on the rate and fees you pay for a mortgage, which is a big reason you want your scores to be as high as possible. Lenders price credit score risk is through loan-level price adjustments, or LLPAs, which are essentially charges for various risk factors, including credit scores. LLPAs are usually charged as a percentage of the loan amount and are either paid in the form of additional closing costs or are absorbed by the lender in exchange for a slightly higher interest rate.
Low credit scores get hit pretty hard as you go up in LTV. For example, if you have a 619 credit score and are borrowing 90% of the value of the home (which is a 90% LTV), the pricing hit for credit score is about 3.25% – of the loan amount. If the loan amount is $200,000, for example, that would mean extra costs $6,500 that would either have to be paid as added fees on the loan or absorbed by the lender in exchange for a much higher interest rate.
Hopefully you can see why you want to have strong credit scores when applying for a mortgage! If you don’t, it can really cost you.
How to Keep Your Credit Scores Strong
Before you apply for a purchase mortgage, you want to make sure your credit is in good shape so you can get the best deal possible and eliminate qualifying headaches. The following are a few ideas on how to keep your credit scores strong:
- Make all payments on time without fail. The most important factor for keeping your credit scores strong is making all payments on time, particularly mortgage payments. Not only does your mortgage payment history affect your credit scores, but lenders will look at it as a separate qualification by itself. These days you need to have a perfect mortgage (or rent) payment history for at least the last 12 months to qualify for a new mortgage. You may get away with one late payment greater than 30 days (but less than 60 days) for some programs, but it’s better to just make your mortgage payments on time.
- Check your credit report often and clear up any errors right away. If you find errors on your credit report, contact the credit bureau that is reporting the offending account to get it cleared up as soon as possible.
- Clear up any derogatory items. If you have old unpaid accounts that are still open as collections or charge offs, get them cleared up as soon as possible. Even if the accounts are small and old, they can still damage your scores.
- Keep revolving accounts below 30% of the outstanding limit. The credit bureaus hit your scores hard if you have a high credit utilization on revolving accounts (like credit cards) – even if you make your payments on time. If you’re carrying a lot of credit card debt, it might be a good idea to first focus on paying down debt before attempting to qualify for a purchase loan. This will not only lower your debt utilization, but you’ll also have a lower debt-to-income ratio.
- Make sure your home equity line is reporting as a mortgage debt. If it shows up as a revolving debt, then it will be treated by the scoring algorithms like a credit card and could damage your scores if you’re carrying a balance higher than 30% of the limit (as mentioned above). If you do see this kind of error on your credit report, be sure to contact your bank to get it fixed.
- Keep older credit card accounts open. A lot of people have made the mistake of closing out older, well-established credit card accounts because they think it will help their scores to reduce available credit. Big mistake! If you’re going to close out accounts, make sure to keep a few of your oldest ones open. Credit bureaus like to see long credit histories, so don’t chop your credit scores by chopping old accounts.
- Don’t cosign. Even if the person you cosign for pays the bill on time, cosigned accounts can still cause some issues when qualifying for a home loan. I highly recommend that you avoid cosigning at all. When you cosign, you’re putting your credit in the hands of another person, and if they miss payments or default, it could cause a lot of problems for you. Plus, the bank could come after you for the payments because cosigning makes you legally obligated for the debt.
Past Foreclosure, Bankruptcy, or Short Sale
If you have some major dings on your credit, such as a foreclosure, bankruptcy, or short sale, you probably have some work to do to rebuild your credit before you’ll be able to qualify for a new mortgage. Also expect that mortgage lenders will want you to wait a certain amount of time before they’ll lend to you. Use this time to rebuild your credit profile so that when the waiting period is done, you’ll be ready to get the most favorable financing terms possible.
Get a Copy of Your Credit Report
If you haven’t checked your credit recently, federal law entitles you to a free credit report once per year from AnnualCreditReport.com. Grab a copy of your credit report because you start shopping around for a mortgage so you don’t run into surprises that could throw a wrench in the deal.
If some errors pop up on your credit report, be sure to get them fixed as soon as possible. It can take some time for the corrected information to show up in your credit file, so it’s important to get working on clearing up errors early so they don’t hold up the loan qualification process. The Federal Trade Commission (FTC) website has some great information about how to dispute credit report errors.
Credit is super important for securing a home loan. The higher your scores the better! If your scores are in the fair range or worse, you could end up paying thousands or tens of thousands more over the life of the loan in added interest and fees (assuming you even qualify at all).
If you haven’t pulled a copy of your credit report recently, it’s important that you do so ASAP. Clean up any errors you find and be sure to manage your credit as explained here. This will help get your credit whipped into shape so you can more easily qualify and get a great mortgage deal.
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