Preparation to buy a home should start long before walking through a potential home option. The first step to buying a home should always be meeting with a mortgage lender to determine where you stand in eligibility for a home loan. But what if your credit score, a critical piece of the homebuying puzzle, doesn't make the cut?
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The good news is that you now know where you stand score-wise and where you need to be in terms of having a credit score qualified for home financing. Here are several steps to improve your credit score when preparing to buy a home.
Check for Errors on Your Credit Report
An estimated one in five credit report contains a serious error, according to the Federal Trade Commission. Disputing an error is one of the fastest ways to improve your score. For example, an inaccurately reported late payment can drop your score 60 to 110 points, depending on your credit history.
Negative items, not including bankruptcy, should only appear on your credit report for seven years. Commonly disputed errors include:
- Reported late payments that were actually on time
- Inaccurate credit limit
- Inaccurate loan or account balance
- Accounts that do not belong to you
- Inaccurate account status, such as a past due account which is current
Pay Down Your Credit Cards
While paying off installment loans, like mortgage, auto, student, etc. can help increase your score, minimizing balances on revolving accounts like credit cards will increase it faster. Account balances are on the biggest factors affecting your credit score.
Carrying a balance doesn't necessarily make you a high-risk borrower, but a high percentage of credit lines in use or "maxed out" do lower your score. Keep balances below 30 percent of the credit limit on each card; below 10 percent is an ideal goal.
Don't Close Old or Unused Accounts
While closing a zero-balance account will decrease the temptation of using that credit card, it rarely improves your credit score. Closing unused accounts not only lowers the amount of revolving accounts, which is an indication of creditworthiness, but it also decreases your total amount of available credit. Closing an account, specifically an older card, also shortens the timeline of your credit history.
Don't Open New Credit Accounts
When you apply for a new credit card, the creditor analyzes approval based on a copy of your credit report. This is called a "hard inquiry". Too many hard inquiries on your credit report can indicate a risky borrower and may drop your score.
Don’t Pay Off Old Collections…Yet
Your lender will run your credit report during the pre-approval process, and if there are any outstanding collections, they will let you know. Before you pull out the checkbook to pay them off, wait for the go-ahead from your mortgage banker.
Paying an old bill that went to collections brings that discrepancy to the present and can drop your score drastically. During the underwriting process, your bill in collections will most likely become a pending condition to close.
Pay Your Bills on Time
While timeliness of bill paying may seem like a no-brainer in improving your credit score, it is a struggle for many consumers. Payment history is a huge part of what determines your score, so if you are often forgetful, sign up for payments to automatically withdraw from your account.
Building Limited Credit History
Sometimes potential homebuyers face a different type of issue with their credit score; instead of having a less-than-eligible score, they have too limited credit history. Certain loan types allow borrowers to use what is referred to as non-traditional credit. This allows borrowers to use accounts such as utility bills, phone bills, and rent payments in good standing as proof of credit history.
Talk to your mortgage banker about your options of using non-traditional credit toward your credit score.
Building and Improving Score (May) Take Time
Keep in mind that your credit score isn't determined solely on recent actions. Years of past credit behavior are taken into account to determine your number, and it's impossible to determine how one specific action will affect an individual's credit score. The above recommendations will help keep you on the right track to building better credit.
Be patient and persistent with your improvements - your credit wasn't damaged overnight, so don't expect the same for rebuilding it. If you have any questions about credit decisions while trying to improve you score, talk to your mortgage banker for suggestions.
Looking for more information about buying your first home? Our free Mortgage 101 Handbook is the ultimate home financing and buying guide for first-time homebuyers.