Credit Scoring for Home Buyers
If you’re reading this series for the first time, you might want to start with Part 1
Outside of the Front End DTI, nothing effects your payment more than credit score. A number of good resources exist for figuring out acceptable credit scores for home buying, but a general rule of thumb is that your interest rate increases with each step down the ladder you take from a prime score. Prime in the context of home buying is generally a middle score of 740 or higher, with the scores coming from Equifax in FICO Version 5, Experian in FICO Version 2, and TransUnion in FICO Version 4 for loans that will get purchased by Fannie Mae or Freddie Mac. With two buyers, the lower score will be used for lending purposes. Scores in the mid 500’s will qualify for certain loans, but will be expensive in most cases.
How do I find my score?
Getting a free score online through your credit card or a web service will likely not give you clarity on your mortgage specific credit score. I highly recommend pulling a full score profile 6 months to a year in advance. Use a premium service like myfico.com ($60 for a one time pull of all 3 scores) and make a concerted effort to repair any concerns found in your report.
How can I improve my score?
Credit scores are not entirely transparent, but there are several strategies that can be used to improve a credit score.
Remove old late payments and collections
If you have any late payment reports of 30, 60, or 90 days or accounts that have slipped into collections, it is time to do some research on ‘pay for delete’ letters sent to your individual lender. This won’t always work, but cleaning up derogatory marks has a huge positive impact on credit scoring models.
Have at least three credit cards, and keep a small reported balance on one.
Credit scoring rewards the responsible use of credit, so having a variety of credit cards is considered beneficial. If you are within 6 months of getting a loan and only have one or two cards, don’t apply for more. If you’ve got a year, go ahead and apply for no fee credit cards. Pay off two of the cards before the statement cuts each month, and pay the other to 9% of its credit line prior to the statement cut date. This keeps your utilization reporting in the best possible bracket. You shouldn’t fail to pay that 9% or less before the payment due date. There isn’t any need to pay interest on the balance to improve your score.
The advice stands from before; don’t take out new credit if you’re close to the finish line. However, a savvy credit builder can take out a ‘shared secured loan,’ which is a loan backed by savings. This allows building another variety of credit, but doesn’t need to be done if you already have a car loan or other installment loan. Much like credit cards, an installment loan has the best possible impact on your score when you have 9% or less remaining as the balance. With a big loan for a car or similar, this is hard to achieve at home buying time. Shared secured loans from certain vendors can be prepaid for months or years in advance, letting them sit in the optimum range for extended periods of time.
Building or rebuilding credit takes time. Negative marks age off, as do credit inquiries. As lines of credit get older, they start to have a greater positive impact. If you have plenty of time before you’re thinking about home buying, start building credit now and leave it unbothered for as long as possible.
Stay on track
Don’t miss a payment for any reason. The negative impact of a single missed payment can cost you thousands over the life of your home loan! Also, don’t even think about applying for new credit after you’ve made an offer on a house and before closing. This can derail your entire lending process.
Come back next week for Part 3, When to Rent Instead!