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You don't need perfect credit to buy a house, and some loan programs are even available to homebuyers with credit scores in the 500s. But the higher your credit score, the better your chances will be to score a low interest rate on your mortgage.
So, while you may be able to get approved with your credit profile the way it is now, here's how to buy a house with the best financing terms you can get:
- Find out where your credit stands
- Dispute inaccuracies on your credit reports
- Address specific issues holding you back
- Avoid opening new credit accounts
- Keep old credit cards open
- Pay off smaller debts
How to fix credit to buy a house
It's good to always keep an eye on your credit score. If you do, you may not need to take time to improve your credit before you apply for a mortgage.
But if you've had some difficulty keeping your credit on track, here are some steps you can take to establish credit good enough to buy a house with the best terms possible.
|1||Find out where your credit stands||
Start by checking your credit score to get an idea of what your credit health looks like. While you can typically get approved for a conventional loan with a 620 FICO score – and FHA loans can go as low as 500 with a 10% down payment – your best bet for a low interest rate is to have your score in the mid-to-high 700s.
You can get free access to your FICO credit score through Experian's free credit monitoring service or Discover Credit Scorecard. Also, many credit card companies offer free FICO score access to their customers.
Once you have your credit score, request a copy of your credit reports. You can get a free copy of your report from each of the three national credit bureaus – Experian, Equifax and TransUnion – through AnnualCreditReport.com.
|2||Dispute inaccuracies on your credit reports||
Sometimes, credit reports contain inaccurate information. As you review your credit reports, check for information you don't recognize.
Once you file a dispute, the credit bureaus will typically take 30 days or less to investigate and verify your claim. If the item has been impacting your credit score negatively, removing or correcting it could increase your score. If you're in the midst of the mortgage process and find an error, you may be able to fix it and request a rapid rescore.
Rapid rescoring is a service some lenders offer that can get your credit reports updated quickly to improve your credit score, says Christopher Rosenbergen, First Vice President of Retail Lending and Financial Services at Ulster Savings Bank in Kingston, New York. "It’s worth utilizing when you have an error or an account that isn’t reporting updated information."
"The downside to rapid rescoring is there’s often an additional fee, and it won't remove accurate negative items from a credit report," says Ryan Dibble, Chief Operating Officer at Flyhomes, a real estate brokerage in Seattle.
|3||Address specific issues holding you back||
You'll also want to review your credit reports for legitimate issues hurting your credit score. For example, if you've missed a payment, you can't get it removed from your report because it's not inaccurate. But you can get current on the account and make it a priority to pay on time going forward.
You may also want to look at your credit utilization rate, which is the percentage of your available credit on credit cards you're using at a given time. For example, if you have $50,000 in available credit and $20,000 in credit card debt, your utilization rate would be 40%.
That's not to say you shouldn't use your credit cards at all, though. "This seems a little counterintuitive, but using your credit accounts and paying them off responsibly actually helps your score more than not using your accounts at all," says Dibble.
Just be sure to avoid carrying a balance every month – your balance is typically reported around the statement date, so paying it off in full by the due date won't give you a 0% utilization rate.
As you review all the different negative items bringing your score down, take actionable steps to address them.
|4||Avoid opening new credit accounts||
When you apply for a mortgage, you want your credit to look as good as possible. But opening a new account adds another hard inquiry to your credit reports and also reduces the average age of your credit accounts – and both of those results can hurt your credit score.
Also, because a mortgage is a significant debt for you and the lender, any other debts you add to your life can increase the likelihood you won't be able to make your monthly mortgage payment. If you do open a new credit account in the months leading up to your mortgage application, expect the lender to ask you to explain why you opened it.
|5||Keep old credit cards open||
Closing an old credit card you never use may not seem like a big deal. But as long as that account stays open, it helps boost the length of your credit history, which is a plus for your credit score. If you close the account, you'll also take away that account's available credit, which will increase your credit utilization rate.
In some cases, it may be worth it to close an old credit account. For example, if the credit card has an annual fee or a security deposit and you no longer use it, you might want to avoid the extra costs or get your money back. Also, if you've had trouble with overspending, getting rid of the temptation is likely a good decision.
But if you can help it, avoid canceling your card until after your mortgage closes, so you can maximize your credit score.
|6||Pay off smaller debts||
Your debt-to-income ratio is another important factor lenders consider when you apply for a mortgage. It primarily helps the lender determine how much you qualify for in terms of the monthly mortgage payment.
"Lenders want some assurance you can afford the new home based on the projected monthly payments," says Rosenbergen.
The ratio is calculated by dividing your total monthly debt payments by your gross monthly income. For example, if you have debt payments equaling $800 every month and your gross income is $2,500, your debt-to-income ratio is 32%. The standard recommendation for lenders is borrowers shouldn't have a debt-to-income ratio higher than 43%. With this example, a mortgage payment higher than $275 would make your debt-to-income ratio more than 43%.
But let's say one of those loans has only $1,000 left on the balance, and the monthly payment is $200. If you were to pay off the loan, your debt-to-income ratio would drop to 24%, giving you some more breathing room.
Keep up your efforts until you close
While it's important to understand how to fix credit to buy a house, you'll want to maintain your vigilance throughout the mortgage process, not just before you apply. That's because mortgage lenders will typically run your credit again shortly before you close to make sure you still qualify for the terms they've offered you.
If you've opened a new account, racked up a high credit card balance, missed a payment or done something else to hurt your credit score, it could put your home purchase in jeopardy. Make sure you're focused on maintaining your good credit habits until you have your keys in hand.
Monitor your credit regularly going forward
Now that you've established credit good enough to buy a house with favorable terms, resist the urge to be complacent about your credit score. While you may not need to get another mortgage anytime soon, you may still need financing in other areas of your life, and if you have to take steps to build your credit every time, it can be exhausting.
"It's never too early to prepare your credit," says Rosenbergen. "Since your credit quality and score can affect many different aspects of your financial life, you should always be working on it."
At the very least, use a credit monitoring service that offers real-time alerts when changes are made to your credit reports. Also, plan to check your credit score at least once every month to make sure you're still in good shape. If something causes your score to drop, address it immediately.
Building good credit can require time and patience, but once you've done it, maintaining it can be a lot easier.
Source: U.S. News