How to Improve Your Credit Score Before You Apply for a Mortgage
Your credit score is one of the most important parts of the mortgage process. Lenders use your score to assess your creditworthiness as well as how much money they lend you and what mortgage rate they charge you. Borrowers with credit scores above 680 to 700 typically receive a lender’s lowest rate and most attractive loan terms. Borrowers with lower credit scores are usually required to pay a higher interest rate and in some cases make a larger down payment. You may make a lot of money, have minimal debt and can afford a high monthly mortgage payment but a low credit score could potentially prevent you from getting a mortgage or make it more expensive. And just a small increase in your mortgage rate can cost you thousands of dollars more in interest expense over the life of your loan. Additionally, most low down payment mortgage programs require a minimum credit score so a low score may disqualify you from certain programs.
Because your credit score is so critical, we recommend that you get a handle on your score long before you apply for a mortgage. Understanding your credit profile in advance of applying enables you to take action to to fix your score. For example, you can identify and resolve issues on your credit report such as identity theft, late payments and accounts in collection. You can also decide to pay off or pay down debt accounts which has the double benefit of boosting your credit score and improving your debt-to-income ratio, which means you can qualify for a higher mortgage amount. For some borrowers, a low score is the result of a limited credit history so you may actually want to open a handful of new credit accounts. It is also important to understand how to deal with really serious credit issues such as bankruptcy or foreclosure. In short, there is a lot you can do to lift your credit score before you get a mortgage, all of which should improve your loan terms.
Below we outline how to improve your credit score before you apply for a mortgage. Follow this advice to help you identify and fix credit issues which ultimately enables you to save money on your mortgage. We caution against working with companies that promise to fix your credit for a fee. In fact, the good news is that you can implement all the measures below on your own at little or no cost. So continue reading to learn what you can do to boost your credit profile long before you submit your mortgage application.
Check Your Credit Score
FREEandCLEAR recommends that you check your credit score and report at least six months before you apply for a mortgage. Checking your score that far in advance allows you to identify any issues with your credit profile, take steps to address them and increase your score. Additionally, it can take several months for your credit score to reflect any improvements you make to your credit profile so you want to give yourself sufficient time so you can actually benefit from a higher score when you apply for your mortgage.
Review the Credit Score Required for a Mortgage
It is important to note that checking your score will not hurt your score and you can continue to check your score regularly without hurting it so you can track your progress. You can check your score and review your credit report for free on web sites and apps. If you are applying for a mortgage with a spouse or a partner you should both check your credit scores as lenders typically use the lowest score among multiple borrowers.
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Identify and Address Issues on Your Credit Report
Checking your credit score long before you apply for your mortgage enables you to identify and address any significant issues on your credit profile such as late payments, accounts in collection or charge-offs. If you are late on any payments, bring those accounts current. If you have any accounts in collection, work with those creditors to resolve the issue and settle the accounts. Please note that if you settle an account for less than the amount of money you owe, that will be indicated on your credit report so it may be better to establish a payment plan to pay off the debt. If you identify any issues that are false or inaccurate work with the creditor and credit bureaus to remove the item from your credit report. Removing an item from your report can take significant time and effort but you want your report to be as accurate as possible.
You should also draft a factual explanation of the credit issue to provide to lenders. Avoid including excuses or unnecessary details but accurately describe the issue and the steps you have taken to resolve it. When you apply for your mortgage a written letter of explanation is always more effective than a verbal summary to a lender. When you clean-up your credit profile you may not see a higher score the next day but it will go a long when when you apply for your mortgage.
Pay Off or Down Debt
One of the ways to improve your credit score is to pay down or pay off some of your monthly debt such as a credit card or car loan. Paying down your debt provides two benefits:
First, paying down debt lowers your credit utilization rate, or how much of the credit available to you you are using. Credit utilization rate is one of the factors that determines your credit score. You typically achieve a higher score if your credit utilization rate is less than 30%. So if you have a $10,000 limit on your credit card, your outstanding balance would be less than $3,000. The credit bureaus like that you have access to credit but do not want you to use too much. Paying-off your balance completely but keep the account open that is best possible scenario when you apply for a mortgage but that may not be feasible financially
Second, paying down your debt also improves your debt-to-income ratio which allows you to qualify for a larger mortgage amount. When you apply for a mortgage, a lender reviews the ratio of your monthly debt (total monthly housing expense plus other monthly debt payments including credit card, student and auto loans) to your monthly gross income. Lenders typically apply a maximum debt-to-income ratio of 43% - 50% which means you can spend 43% - 50% of your monthly gross income on your mortgage and other debt payments. So the lower your monthly debt expense the higher the monthly mortgage payment you can afford. For example, if you reduce your monthly credit card payments from $500 to $0, that means you can spend $500 more per month on your mortgage which enables you to qualify for a larger mortgage amount
Review Debt-to-Income Ratio for a Mortgage
Examples of paying down or paying off debt include paying off a car loan, refinancing a student loan, paying down your credit card balance or transferring your credit card balance to a card with a lower interest rate, which also reduces your monthly debt expense. It is important to note that even if you pay off your credit card balance completely you should keep the account open, unless you have too many accounts which can also hurt your score.
Consider Prudent Ways to Improve Credit Access
Not accessing credit can hurt your credit score. The credit bureaus that determine your score like to see that you have a history of accessing and paying back loans. Fair or not, borrowers who have not had many loans or credit accounts in the past typically have lower credit scores, even if they have no track record of late payments or other credit issues. Borrowers with limited credit profiles should consider expanding their credit history by opening one-to-two new loan accounts, such as a credit card, even if you do not intend to use it. Opening a credit card account demonstrates that you have access to credit and helps you establish your credit history.
A couple of points about opening a credit card account: 1) open an account with a low interest rate and no annual fee, 2) opening five accounts does not provide five times the boost to your score -- opening one or two accounts works fine, 3) open the account five-to-six months before you apply for a mortgage, opening an account within one-to-two months of applying for a mortgage can be counter-productive
Another way to improve credit access is to add your rent payment history to your credit profile. Depending on the type of property you rent and your landlord, your rental history may not be on your credit profile. While adding your rent payment history to your credit report technically does not improve your access to credit, it demonstrates your ability to make a significant monthly payment on a timely basis, which helps your credit score. You can add your rental payment history to your credit profile by contacting the credit bureaus or working with third parties that provide this service for a fee.
What About Really Serious Credit Issues?
A serious negative credit event such as a bankruptcy, foreclosure, short sale or default can make it very challenging for you to get a mortgage. Lenders typically impose waiting periods after these events before you can apply for a mortgage. For example, the waiting period to apply for a conventional mortgage following a foreclosure is seven years and three years for an FHA mortgage. The waiting periods are significantly shorter if you experienced an extenuating event such as a job loss or medical hardship that caused your income to drop for an extended period of time. For example, if you experienced an extenuating circumstance, the waiting period to apply for a conventional mortgage is only three years and one year for an FHA Mortgage.
Review Mortgage Waiting Periods After Credit Issues
As with all credit issues, we recommend that you draft a written explanation of what caused the adverse credit event and what steps you have taken to address the issue. Additionally, outline any extenuating circumstance that attributed to the event and collect supporting documentation to verify the circumstance. For example, gather hospital bills if you experienced a medical illness or a termination notice if you lost your job. The lender will likely request this information when you apply for your mortgage.
Learn How to Get a Mortgage with Bad Credit
It usually makes sense for you to wait until your credit profile improves following a serious credit event before you apply for a mortgage as financing from traditional lenders may not be available to you. If you do not want to wait, you could consider working with a hard money, or private money, lender although these lenders typically charge a much high interest rate and fees and require a higher down payment.
Use the FREEandCLEAR Lender Directory to find private money lenders and lenders that offer mortgage programs for credit-challenged borrowers.
Get Pre-Approved But Only When You Are Ready
When you apply for a mortgage, or in some cases apply to get pre-approved, lenders pull your full credit report as opposed to simply reviewing your credit score. When a lender pulls your credit report this counts as a hard inquiry and is different than you checking your own score on a regular basis, which is known as a soft inquiry. Too many hard inquiries can have a negative impact on your credit score so you should wait until you are ready to apply for your mortgage before contacting lenders. You do not want to apply for a mortgage or pre-approval multiple times over several months.
Please note that when multiple lenders pull your credit score within a specified time period, this only counts as one event so the borrower is not penalized for comparing multiple lenders when shopping for a mortgage, which we recommend that all borrowers do.
If you are considering applying for a mortgage we recommend that you use our free get pre-approved feature to connect with lenders and resolve any issue with your loan application. Our pre-approval form is easy-to-use and does not negatively impact your credit.
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Put Off Major Purchases Until Your Mortgage Closes
We recommend that you put off any major purchases such as buying a new car until after your mortgage closes. A major purchase can have an adverse impact on your credit score and any additional monthly debt payments could also hurt your debt-to-income ratio which means you would qualify for a lower mortgage amount.
It is important to emphasize that you should wait to make a major purchase until after your mortgages closes and not just until after you have been approved for your loan. Lenders check your credit report when you apply for a mortgage and then they typically check your credit profile again right before your mortgage closes to make sure there have been no significant changes. If your credit score declines or monthly debt increases significantly from the time you are approved for a mortgage until when your mortgage closes, the lender may cancel your loan so it is best to hold off on any major purchases.
Sources
“How do I get and keep a good credit score?” CFPB. Consumer Financial Protection Bureau, March 29 2019. Web.