Know your credit: steps to take before you apply for a mortgage

Know Your Credit: Steps to Take Before You Apply for a Mortgage

Your credit rating is one of the most important numbers in your life – it determines whether you will qualify for and how good an interest rate you will receive on car loans, store cards and credit cards, as well as a mortgage. Many financial advisers may tell you that it is essential to have a good credit score before you can even think of applying for a mortgage, and that it may take up to six months (and sometimes even longer) to fix poor credit.

Once you apply for a mortgage, the lender accesses your credit report, which is based on information supplied by the three main credit-reporting agencies – Equifax, Experian and TransUnion. Your credit score should be somewhere between 300 and 850; this score is based on factors such as the length of your credit history, your available credit, the amount of credit you have used, and employment history. This number is your FICO score (named for the Fair Isaac Reporting Company).

Mortgage lenders look at several risk factors when deciding whether to approve a mortgage. A potential home buyer who pays all their bills on time and does not have more credit than they can deal with is probably a safe risk when it comes to lending them the cost of a home. The higher your credit score, the more options and better interest rates you can quality for. A score of 760 or over is considered risk-free by the mortgage industry; a score between 600 and 700 is still good.

A credit score of less than 500 means that it may be difficult to find a lender who will work with you, although it is not impossible. Some lenders – known as sub-prime lenders – specialize in loans to buyers with poor credit, although your interest rate may almost certainly be higher. Some other options are to increase your down payment if possible, or to apply for an FHA or VA loan, which use different criteria to qualify borrowers.

So what should you do if you are buying a house, but do not have the best credit in the world? Amazingly, around 25% of credit reports have serious errors in them which can significantly affect the interest rate you are offered – so the first thing you should do is to check yours and make sure it is accurate. It is fairly easy to fix any mistakes on a credit report, although it can take several months, so it is a good idea to check your report before even beginning the house buying process.

Think twice about buying a new car if your credit is less than excellent – the amount of credit given to you can affect your score and the interest rate you are offered. Unless your credit is excellent, try to wait and buy the car – or any big purchase – after you have closed on your new home. You may consider buying a second hand car or paying an existing car loan off earlier, if possible. Buying a home and then buying the car should not affect your credit rating, by the way.

If you have several credit cards, try to get the account balances down as much as you can before you apply for a mortgage – ideally, to around 30% of their limits. Better still, just do not use one or more of your cards, although you should still keep the accounts open to prevent losing points and to show that you still have available credit. It is also worth calling your credit card company to inquire about lowering the interest rate and to remove any late or skipped payment records.

Try to keep at least one long standing credit account – if you have had a credit card for several years, keep that one. Lenders approve of borrowers who have a long credit history and can show some stability. If you have department store credit, try to pay this off and keep an actual credit card. You may see an improvement in your credit score if you go for several months without applying for any new credit or loan; although checking your own credit score will not affect it.

Paying your bills on time also helps build up your credit score. We all miss a payment occasionally, but you should not do it too often. Lenders are looking for a record of timely payments and stability; in fact, this is the single biggest factor when it comes to your credit score. If you know you are going to be late paying a bill, notify the lender involved – this may allow you to keep the late payment from affecting your credit score.

If you are planning to buy a house, it is worth taking the time to understand how the system works – especially when an interest rate of just one point less can mean a savings of around $50,000 on the average 30-year mortgage.

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