On the road that leads to homeownership, there are a lot of steps. However, just as the old proverb says, “A journey of a thousand miles begins with a single step”. In this series of articles, we will walk you through several of the crucial steps that many homeowners before you have taken. Along the way, we will give you some tips and advice on how to navigate this journey so that, someday, you will step over the threshold of your very own home.
Step 6: Credit & Housing: How to Get Homebuyer Ready
There is a direct link between the health of your credit score and how easily you can purchase a home. The higher your credit, the less you appear to be a financial risk to potential mortgage lenders, which translates into lower interest rates and larger amounts of money they are willing to loan you. The process of purchasing a home can be overwhelming enough, and this can be made even more stressful when you have a low credit score.
However, by better understanding how your credit score functions in this capacity and some steps that you can take to repair it, you can conquer some of that trepidation and make yourself a bit more homebuyer ready.
First, a Few Key Highlights:
- Get Your Credit Report. Knowing where you currently stand is imperative to improving your position. You have a right to a free annual copy of your credit report from all three of the major credit bureaus – Equifax, Experian, and TransUnion. Request these and dispute any mistakes you find on them.
- Maintain a Few Lines of Credit. Many lenders require that you have a minimum of three active lines of credit open within the last two years or so. Car loans, credit cards, student loans, or a year worth of rent checks should all be sufficient forms.
- Keep Your Accounts Open. The age of your credit is heavily considered, so the older a line of credit is the better. Even if they are paid off and you haven’t used them in a while, refrain from closing these kinds of accounts.
- Don’t Open New Accounts. Opening new lines of credit within six months of applying for a mortgage loan sends up a red flag for most lending agencies. It raises your debt-to-income (DTI) ratio and makes you seem like a higher risk.
- Resist Charging Big Purchases. Hold off on making large purchases to fill out the new home you are envisioning. This likewise will raise your DTI and can raise your monthly mortgage payment and your interest rate.
Can you Buy a Home With Poor Credit?
While it does greatly affect the application process, getting approved for a mortgage loan depends on more than your credit score alone. Because of this, it is absolutely possible to purchase a home even when your credit is less-than-ideal.
Though it is possible, a low credit score will likely make your appraisal more difficult. It is still wise to consider any steps that you could take to repair your credit before you apply and improve your chances. Many conventional mortgages require a score of at least 620 to secure them, however, these are the other factors that are taken into consideration:
- Credit History
- Debt-to-Income (DTI) Ratio
- Household Income
- Large Savings Accounts
- Sizeable Down Payment
- Stable Employment History
It should be noted that you should avoid any mortgage loans that guarantee approval regardless of your credit score. These types of offers typically mean only one thing – an insanely high interest rate.
What Exactly is Credit Repair?
The term credit repair is used for any method you might employ to help raise your credit score. It could be as simple as disputing errors found on your credit reports, as mentioned above. Some studies have found that 1 in 3 people in the U.S. has at least one mistake present on their credit report. Which means that it is arguably the best place to begin.
Every consumer is guaranteed access to an accurate, fair, and fully substantiated copy of their own credit report under the Fair Credit Reporting Act. Though we touched on this already, it is worth mentioning a second time – take advantage of this law.
And while repairing your own credit is entirely possible, there are people who feel that they do not have the time or the know-how to do the work themselves. If this is the case, there are credit repair companies that can dispute erroneous entries on your credit report. These professionals have gone through the process of disputing these kinds of things before and understand how to properly do so. Just be aware that they have no special access or legal recourse that you do not – there is nothing they are able to do that you could not do yourself. And we’ll tell you how in just a moment.
You should also be aware that the industry of credit repair draws a lot of scammers. Do your homework and thoroughly research the legitimacy of any company you are thinking about hiring. If anyone claims that they can remove accurate and verified information from your credit report, consider that a red flag.
Repairing Your Own Credit: 5 Tips
Understanding Your Current Score
Now that you have the three copies of your credit report in hand from the three big credit reporting agencies (Equifax, Experian, and TransUnion), what’s next? Now it’s time to learn how these reports become your credit score.
Whenever a potential lender pulls a credit check on you, the data from one of these three credit reports is run through an algorithm by a credit scoring company (usually either FICO or VantageScore). The algorithm then generates a three-digit number that represents how financially reliable you are to loan money or credit. The higher that number, the lower the apparent risk to that particular lender. Here are the factors used to determine your credit score, listed from “most damaging” to “least damaging”:
- Bankruptcy
- Foreclosure
- Repossession
- Loan default
- Court judgments
- Collections
- Past due payments
- Late payments
- Credit rejections
- Credit inquiries
Just remember to be honest with yourself while you read through your credit report. You know best if you missed a payment or not. But you have no reason to be ashamed or defensive, financial problems happen to people all of the time. Moving forward, however, repairing your credit can only happen if you are ready to be truthful and make the necessary changes to build things back to a healthier place.
Disputing Incorrect Information
Though we have mentioned it here already, it bears further explanation. If you do find any mistakes on any of the copies of your credit report, you should immediately file a dispute with that credit bureau. You are not only well within your rights to file such a dispute, but when you do, that company must perform an investigation into the claim. If the entry is found to be incorrect, it must be corrected or removed from your credit report. If this is the situation you find yourself in, depending on the circumstances of that false information, it could give you a significant boost to your credit score.
It is also important to understand that the three different credit bureaus do not necessarily contain the same information. Creditors have a choice as to who they report their information, and there are many who do not report to all three of these institutions. Make a separate list of inaccuracies for each of your reports and then file a 609 Dispute Letter to each one of them where you might have found inaccurate information. Send that letter with a return receipt request and ask that the information in question be verified. Be aware, however, that this type of dispute typically takes four or more weeks to process.
When you are reviewing your credit reports, pay special attention to any accounts that you do not recognize as yours. If you find any entries that you outright do not believe are ones that you opened, you should report them immediately to the Federal Trade Commission. This is a possible sign that you may be the victim of identity theft. If fraud protection is something that you are concerned about, many credit card issuers offer credit monitoring services. Additionally, you could think about locking or freezing your credit entirely, which would prevent anyone from opening additional lines of credit in your name.
As with all stages of your credit repair journey, make certain that you document everything as closely as you can and stay as organized as possible. Keep all of your mailing receipts and copies of any correspondence you have with the credit bureaus. Likewise document every phone call you have with creditors or credit reporting agencies. Write down the name of the person you spoke with, their title or position, their direct line or extension number, the date and time of the call, what was discussed, and what you both agreed to. According to law, the dispute is not supposed to go longer than 30 to 45 days, but if it does, you may have to prove that it has gone over that limit. In such a situation, having thorough documentation will help you plead your case.
Pay Down Your Existing Debt
Though it is difficult to think about when you are starting to save for the purchase of a home, it is vital to do what you can to pay off some of the debts that you owe. This will take time to accomplish, but it will go a long way to repairing your credit. According to the FICO rating system, your existing debt constitutes nearly one-third of your entire credit score. And once the debts are cleared, then you can start to rebuild your finances in a much stronger condition.
One possible solution for managing and paying off multiple debts at the same time is debt consolidation. This bundles all of your bills together into a single loan that carries just one monthly payment. Make sure that you familiarize yourself with the interest rate of any contract you are thinking of signing, as these services can sometimes come with an interest rate that is very high. Also, keep in mind what we discussed in the key highlights section above – try to keep as many credit cards open and unconsolidated as you can. Again, the older an account is, the better your credit will appear to potential lenders. If you are spending too much on your cards, try putting them in a safe place until you absolutely need them. Some people hide or shred the physical cards themselves, only keeping the information from them someplace safe. There have even been a few people who literally freeze their cards in ice and store them in the freezer.
Alter Your Financial Habits
As a part of taking an honest and truthful look at what damaged your credit in the past, you need to identify your own harmful financial behaviors that might be the culprit. This isn’t about blaming yourself for past mistakes, it is entirely about preventing future ones. Establishing healthier financial habits now can prevent you from having to go through the credit repair process ever again. Try adopting these three habits:
- Always pay on time. This has the single largest impact on your credit score. Make this your first priority.
- Keep a low balance. Your credit utilization ratio needs to be kept below 30% whenever possible. This is the amount of credit you currently have compared to your limit. Pay the majority or all of any large purchase you make on your cards within a month of the initial charge.
- Don’t borrow more than you can pay back. It can be very tempting to take advantage of the extra capital available to you, but you should avoid spending beyond your budget. Do not borrow more than you can realistically pay off at the end of the month.
Give Yourself Time
Even if you implement all of these changes at this very moment, it could take months or possibly even years to get your credit to the point where you feel ready to purchase a home. At times you may feel frustrated at how slow the progress moves. Just know that all of the work and diligence you are putting in will make a difference. Give your accounts, habits, and strategies the time they need to build up your new financial foundation. Have patience, and soon enough, you will be ready to move forward on your journey to homeownership.
