Saving money for a down payment and getting your financial paperwork in order are important ways to prepare to buy a home, but perhaps the most essential step when you’re ready to buy is to improve your credit profile. The average FICO (Fair Isaac Corporation) credit score in April 2015 was 695. Most lenders require a minimum credit score of 620 or 640 to approve you for a loan.
Your credit score not only impacts whether or not you can qualify for a loan, it also influences your interest rate if you opt for conventional financing rather than a government-insured FHA loan. Lenders require a credit score of 740 to receive the lowest interest rate on a conventional loan. Lenders who offer FHA loans still rely on your credit for a loan approval, but the mortgage rate you pay will be the same regardless of your credit score.
Start with your credit report
By law, you can request a free credit report from each of the three credit bureaus (Experian, TransUnion and Equifax) once per year at www.annualcreditreport.com. You’ll have to pay a small fee to get your credit score from each bureau.
Once you have your report, review it for errors and an explanation of any negative information. A recent study by the Federal Trade Commission (FTC) showed that one out of every four consumers had a mistake in their report that could impact their credit score. Each credit reporting agency provides information about how to dispute a mistake, but typically you need to contact the agency and the original creditor in writing.
If your credit report has incorrect negative information it can take a few months to have it removed, but valid negative information such as a foreclosure or bankruptcy will stay on your credit history for 7 to 10 years. An unpaid tax lien will stay on your credit report for 15 years and a judgment will be on the report for 7 years.
However, even with some negative facts on your credit history you can improve your credit score yourself over time.
Improve your Credit Score
If your credit reports are accurate, the next step is to change your financial behavior.
According to FICO, one of the most important contributors to a better credit score is paying your bills on time. Take these steps to boost your credit score:
- Set up payment alerts. You can use an online banking system or request email alerts from your creditors to remind you to pay a bill. Another option is to set up automatic payments through your creditors, but this typically only makes the minimum payment and won’t help reduce your balance.
- Get current on your bills. Take any available cash and bring all your accounts up-to-date to improve your score and eliminate late payment fees and over-limit fees.
- Pay down your debt. Most lenders say you should aim to keep your use of credit below 25 or 30 percent of your credit limit. Stop using your credit cards and tackle one card at a time to pay down your balance. Start with the smallest balance for a psychological boost or pay down the debt with the highest interest rate.
- Split your debt between different credit cards. While it’s best to pay down your debt – and this will also improve your cash flow when you’re ready to buy a home – it’s also good for your score if you’re using less than 30 percent of your credit limit on each card. So rather than have zero balances on several cards and one card with a balance of $4,000 and a limit of $7,500, it’s best to do a balance transfer so you have a balance of $2,000 on two different accounts with credit limits of $7,500 or more.
- Don’t close any accounts. You may want to eliminate your credit cards, but this could actually hurt your score because you’ll have a lower amount of available credit and your credit utilization will be higher.
- Don’t open new accounts. On the other hand, opening new accounts to add to your credit availability can lower your score because it looks like you’re about to go into debt.
- Keep an old credit account open. Your score is also based on the length of your credit history, so be careful not to close your oldest account.
Depending on the level of your credit problems, improving your score could take months to a year or more. The sooner you start making changes, the faster your score will rise.
Interested in a new home in St. Charles? Click here to download our free Homebuyer's Toolkit www.stcharlesmd.com/Toolkit.
Michele Lerner is a freelance writer with more than twenty years of experience writing articles and web content for newspapers and magazines on topics related to real estate, personal finance and business. Her work has appeared in The Washington Post, NewHomeSource.com, Realtor.com, Bankrate.com, Insurance.com, HSH.com, The Washington Times, NAREIT's Real Estate Portfolio, and numerous Realtor association publications. Her latest book, "New Home 101: Your Guide to Buying and Building a New Home" and her first book, "HOMEBUYING: Tough Times, First Time, Any Time" are available now at Amazon.com or from MicheleLerner.com.