How to Improve Your Credit for a Home Loan
To receive the best mortgage interest rate, it is important to prepare your credit for the loan application. Cleaning up your credit report and increasing your credit score will improve your chances of getting approved for a home loan. If your credit’s already good, maintaining it will be key in locking in a low-interest rate.
Learn the best way to build your credit for a mortgage.
Check Your Credit Reports
When you apply for a home loan, the mortgage lender will look for three main things. The first is that you—and your spouse if you apply jointly—have a steady income. The next consideration will be how much of a down payment you can make. The final piece is whether you have a solid credit history.
Your credit history lets lenders know what sort of borrowing you've done and whether you've repaid your debts on time. It also tells them whether you've had any events such as a foreclosure or bankruptcy.
Checking your credit report will let you see what the lenders see. You'll be able to find out if there’s anything that’s hurting your credit.
To check your credit report, request a report from one of the three credit bureaus: Experian, TransUnion, and Equifax. Since you don't know which credit reporting agency your bank will use to evaluate your credit history, you should get a report from all three.
You can get a free copy of your credit report from each of the three credit bureaus by visiting annualcreditreport.com. Federal law allows you to request one free report each year from each agency.
Check Your FICO Score
Your FICO score will affect the interest you pay on your loan, so it's an important factor in your mortgage. A 100-point difference in FICO scores could affect the interest rate on your mortgage by 0.5% or more, costing tens of thousands of dollars over the life of the loan.
You may also be able to see your FICO score from another source. Many credit card companies offer free FICO scores as a cardholder perk. You can also estimate your FICO score using an estimator tool.
Dispute Inaccurate Information
Carefully review your listed credit history for any mistakes. Wrong information may hurt your credit score, causing your application to be denied.
If you spot inaccurate information, dispute it with the credit bureau. Try to find documentation to support your claim; providing proof of the mistake will help ensure it's removed from your report.
Pay Off Delinquent Accounts
If you have any delinquencies, pay them off. Outstanding delinquencies will show up on your credit report, harming your chances of getting a mortgage. Delinquent accounts include any late accounts, charge-offs, bills in collection, or judgments.
Debts that are in collections will affect the payment history portion of your FICO score, which is the biggest component of your credit score. Attempting to repair those problems is a good idea, because lenders may use them when evaluating your mortgage application.
Bury Delinquencies with Timely Payments
Late payments can stay on your credit history for seven years, but they're most damaging when they first occur. If you have a recent late payment—or you've just paid off some delinquencies—try to wait at least six months before applying for a mortgage.
This six-month period will allow the older delinquency to fall further down your record and look less damaging. Meanwhile, six months of on-time payments can help your credit score build back up again.
You need to establish a pattern of making timely payments to get approved for a mortgage. The better your history, the better and more competitive the interest rate you will receive on your mortgage.
Reduce Your Debt-to-Income Ratio
Your bank's mortgage underwriter will question your ability to make your mortgage payments if you have a high level of debt relative to your income. Otherwise known as your debt-to-income ratio, this figure compares the money you have going out (your debt) to the money you having coming in (your income).
Lenders like to see this figure as low as possible. In fact, to get a qualified mortgage, your debt-to-income ratio must be below 43%. In other words, you can't be spending more than 43% of your income on debt.
To reduce your debt-to-income ratio, you can increase your income, perhaps by getting a better-paying job. But it may be easier to decrease your debt, by paying down any outstanding loans or bills and not borrowing more than you can afford.
Don't Incur Any New Debt
Taking on new debt can make a mortgage lender suspicious of your financial stability—even if your debt-to-income ratio stays low. It’s best to stay away from any new credit-based transactions until after you’ve got your mortgage secured.
That includes applying for credit cards, especially since credit inquiries affect your credit score. It also includes auto loans and personal loans, to be safe.
Once you've locked in your mortgage and closed on the house, then you might wish to explore other new debt.