How to fix your credit score to buy a house

Want to buy a home soon but aren’t sure your credit score is high enough to get approved for a mortgage? Fortunately, there are ways to improve your credit to qualify for a home loan with competitive terms. And if your score is on the lower end because you’re a credit newbie or have had a series of financial missteps in the past, fear not: It’s possible to repair damaged credit, too.

Why you should improve your credit score before buying a house

Even if you currently meet a mortgage lender’s minimum credit score requirement, you should aim for the highest credit score possible. That’s because lenders decide your creditworthiness largely based on your FICO scores, and base your loan’s terms on your creditworthiness.

The lowest interest rates are generally reserved for consumers with the strongest credit rating. An interest rate of just 1 percent lower will result in substantial savings on interest over the loan term, as well as a more affordable monthly payment.

As you work to improve your credit score, it’s important to note that not all debt is created equal in the eyes of a lender. “Different forms of debt are viewed differently by those who are approving loans,” says Mark Hamrick, senior economic analyst at Bankrate. “Student loan debt that tends to carry a lower rate wouldn’t be viewed as harshly as credit card debt, which currently carries an average rate of 20.6 percent.”

When it comes to credit cards, Ted Rossman, senior credit card analyst at Bankrate, advises keeping a laser focus on your credit utilization ratio. This represents the limit on your cards versus how much of your credit you’re actually using.

“You want to be on your best credit behavior leading up to a mortgage application,” Rossman says. “Be especially careful about credit utilization during that time frame. For example, if you charge $4,000 against a $5,000 limit one month, it looks like you’re using 80 percent of your available credit, which is quite high. Even if you pay in full before the due date, that high utilization ratio can hurt your credit score. Consider making extra mid-month payments to knock that statement balance down before it even comes out.”

Credit score basics

Before taking the next steps toward improving or fixing your credit health, it’s vital to understand how your credit score is calculated. Doing so helps you know which areas of your credit profile to focus on.

The FICO credit-scoring model, which is used by 90 percent of creditors to make a lending decision, consists of five components:

• Payment history: 35 percent of your credit score
• Amounts owed: 30 percent of your credit score
• Length of credit history: 15 percent of your credit score
• Credit mix: 10 percent of your credit score
• New credit: 10 percent of your credit score

Improving your credit score

There are several ways to improve your credit score before applying for a mortgage. The first step is to get a copy of your credit report from the three major credit bureaus: Experian, TransUnion and Equifax.

Review the reports and identify negative items impacting your credit health, so you know what to focus on first. Also, dispute any errors you find with the credit bureaus and creditors to have them rectified.

Below are some additional actions you can take to get your credit score trending in the right direction.

Reduce your debt

First things first: Get out of debt. A recent Bankrate survey found that 60 percent of people with credit card debt have been carrying that debt for at least a year. Here are some steps you can take to reduce it:

• Pay all your bills on time. A single missed payment could drop your credit score by several points once the account is 30 days past due. Late payments remain on your credit report for seven years, but the negative impact dwindles as time progresses.
• Bring all your past-due accounts current. If any accounts are delinquent, bring them up-to-date to prevent additional adverse credit reporting. You can also reach out to the creditor or lender and request a payment arrangement to get the account(s) in good standing again.
• Reduce your revolving debt balances. The amount of charges you have on a credit card, vis-à-vis the overall credit line, is called your credit utilization ratio or rate. For example, if you owe $15,000 on all your credit cards and the aggregate limit is $30,000, you have a credit utilization rate of 50 percent. Ideally, the balance on your credit card accounts should not exceed 30 percent of the cards’ credit limit. So, using our example, you’d want to decrease the total amount you owe to $9,000 or lower to improve your credit score. However, you don’t have to stop at 30 percent. “FICO says people with the best credit scores often have a credit utilization ratio below 10 percent,” Rossman says.
• Consider a debt consolidation loan. This sort of debt instrument helps improve your credit utilization by rolling your debts into a single loan, preferably with a lower interest rate. You’ll also simplify the repayment process and could save a bundle in interest.

Increase your credit limit

Reducing your debt is good, but you can also tackle things from the opposite end — by increasing your credit.

• Request higher credit limits. Some credit card companies allow you to request a credit limit increase without impacting your credit score. If approved, your credit utilization rate will decrease, assuming you refrain from making additional purchases with the card. A drop in your credit utilization rate could also mean good news for your credit score.
• Transfer balances. If you get an offer for a credit card that offers a zero percent interest rate (usually for a set period, like 20 months), consider transferring the amount you owe on another card to it — especially if the old card has a high APR. Yes, you’ll ding your credit score temporarily, but you’ll also increase your credit utilization ratio. Plus, it’ll be easier to pay off the old debt, since it won’t be generating interest. Just try to do it before the zero percent offer ends.
• Become an authorized user. Ask a relative or friend to add you to accounts with exceptional payment history and a low utilization rate as an authorized user. The account will appear on your credit report and could strengthen your credit health.

Additional ways to improve your credit score

Other strategies can put some polish on your credit score, especially as mortgage application time draws near.

• Don’t close old credit accounts. Even if you pay off the balances, closing credit cards you’ve had for some time causes your average age of credit accounts to drop, which could hurt your credit score. You could also negatively impact your credit utilization ratio.
• Refrain from applying for new credit. Aside from the balance-transfer deals, avoid signing up for new credit cards or taking out new loans of any kind. Each time you apply for credit, a hard credit inquiry is generated, which could cause a slight dip in your credit score. Although the impact is temporary, mortgage lenders frown upon consumers opening new credit accounts shortly before or during the application process.

Credit score minimums by loan type

Mortgage lenders use your middle score from the three major credit bureaus (Experian, TransUnion and Equifax). So, if your scores from the three are 660, 680 and 710, 680 is the figure that will be used to determine the loan terms you qualify for.

Different types of mortgages have different minimums. Here are the credit score minimums by loan type:

• Conventional loans: 620
• FHA loans: 580 (with a 3.5 percent down payment) or 500 (with a 10 percent down payment)
• USDA loans: 640
• VA loans: no minimum is set by the VA (though requirements may vary by lender)
• Jumbo loans: 700

Keep in mind that some lenders have overlays or specific guidelines more stringent than the lending rules set by the FHA, USDA, VA, Fannie Mae and Freddie Mac.

Ideally, you want to aim for a credit score of 760 or higher to qualify for the best rate. But if your score is slightly lower, you could still get approved for a home loan with competitive terms.

Next steps

Aim to take steps to improve your credit as far in advance of your house-hunting as you can. The longer you’ve had a strong score, the better, as far as lenders are concerned.

Get preapproved for a mortgage before you start house-hunting as well — this will give you a solid idea of your borrowing budget and also make you stand out to sellers. When you’re ready to officially apply for a mortgage, you’re not obligated to go with the lender that preapproved you. Shop around and compare various lenders’ rates and terms. You may find that one offers a far more competitive deal than the other, or your credit score needs more work to qualify for better rates.

Finally, a knowledgeable local real estate agent can help you navigate the entire homebuying process, from start to finish.

FAQs

• What credit score is good enough to buy a house?

  There’s no single credit score that will automatically qualify you for a mortgage. The number that’s “good enough” depends on the loan you’re getting: For example, you might qualify for an FHA loan with a credit score as low as 580, but for a conventional mortgage from a private bank or lender, you generally need to have a score of at least 620. Ideally, you’d want a score at least in what FICO dubs the “good” range, 670-739, to qualify for lower rates.
  

• How long do negative marks impact my credit score?

  Late payments, collections and charged-off accounts stay on your credit report for seven years. Bankruptcy filings and tax liens can linger for up to 10 years.
  

• How quickly can you improve your credit score before buying a house?

  It depends on the actions you take. You could see results in as little as a month if disputed items are rectified, or if you pay down credit cards and the updated balances are reported to the credit bureaus. However, it usually takes up to six months to see significant improvements in your credit scores.
  

• Can I buy a house if I have a low credit score?

  You might be able to, yes, but you’ll likely incur higher borrowing costs. Consider a government-insured or government-guaranteed mortgage product, such as an FHA, VA or USDA loan, as the eligibility requirements are generally less stringent than you’ll find with conventional loans.