First Time Home Buyers: Your Credit Score and Buying a Home
If you haven’t noticed already, your credit score is important when applying for any loan. Your credit score will be used by lenders to identify your ability to repay a loan. Their goal is to reduce the amount of risk they may encounter and prevent lending to consumers who have a history of not paying their loan payments.
How credit scores works
Credit scores range from 300-850 and consider your personal financial history including payment history, credit mix, amounts owed, length of credit history, and new credit. Here is a nice graphic from myfico.com that shows a nice breakdown.
It may come as a surprise to you that your credit score takes into consideration a lot of different aspects of how you manage your money. This could be good or bad depending on your financial habits, but it also lays out the road map for how to improve your credit and make smart decisions in the future.
Know your credit score before you apply
If you are ready to buy a home, take a look at your credit score prior to applying for a loan. You may find some surprises and resolving these issues can save you thousands down the road. Depending on the type of loan, the national average minimum credit score ranges between 580 and 620. If your score falls below this number, you may have quite a bit of difficulty finding a lender willing to do business with you. Or, if you do find one, you could be shocked at the interest rate they offer. It's no surprise that the better the credit score, the better the loan rate, as lenders will trust you more. Lenders will often have a higher interest rate for buyers who may be higher risk. When your interest rate increases, your monthly mortgage payment increases and could price you out of the home of your dreams. Even just a few tenths of a percent can make a big difference across a 30-year fixed-loan.
Good credit can save you thousands
For example, here is the current market rate with good credit. As you can see, your total cost of mortgage is just over $850,000 with a monthly payment of $2,364. For some, this may be right at the max of what you can afford monthly.
If you received a loan with a higher interest rate, for our example we will say 4.73%, you will have one of two options. Option one, your monthly payment will increase an extra $238 per month, if you are looking keep the house that costs $500,000 dollars. That results in an extra $85,730 over 30 years that you will pay for the exact same house, just because your credit was bad.
Option two, if you are at your maximum comfort amount for a monthly payment, you could reduce the loan amount. In order to only spend the $2364, your total loan amount would have to decrease $45,800 for a total home loan of $454,200.
Steps you can take to improve your credit score
Check your credit score
When you start thinking about buying a home, you should check your credit score and start working on improving it. Credit scores take a while to improve so the earlier you start taking steps to make it trend upward, the more success you will have when applying for a loan.
30 Percent or Lower
One major factor in your credit score is how much revolving credit you have versus how much you are using. The smaller the percentage, the better. Keeping your balances below 30% helps show that you are not dependent on your credit card. However, even if you pay off your balance in full, your utilization ratio may be higher than you expect. Some issuers report to the credit bureau your statement balance rather than your actual balance.
Reduce the number of credit cards with balances
One indicator of your credit is how many credit cards have a balance. It may be surprising but having multiple cards with small balances may negatively impact your credit rather than having one credit card where all the charges are located. Again, try to keep that total balance below 30% of your credit limit.
Pay on time
This may seem obvious but it’s one we are all guilty of. Delinquency reports are reports you don’t want to see your name on. Lenders are most interested in how often you are unable to make payments on time. Again, lenders want to lend money to consumers who demonstrate the ability to repay a loan. A great solution here is setting an automatic payment so that you never miss a payment.
Be consistent and avoid risk
You have probably caught on that lenders try to avoid risk at all cost when evaluating a loan application. Things like missing payments, or suddenly paying less can indicate financial stress and result in a lower credit score. If you are trying to pay down your loans faster, it may be best to make your typical payment at the beginning of the month and then part way through make an additional payment. This can show lenders financial strength and stability.
As I said earlier, your credit score is responsible for either costing or saving you thousands of dollars. Understanding the components of your credit score can help you focus on the areas where you can improve. Unfortunately, there is no quick fix for improving your credit score. If you are looking to buy a home in the near future, be sure to clean up and dispute any items on your credit report that may be false, pay off old debts, and make your payments on time. Putting in a little bit of upfront work and planning can ensure that once you find the home of your dreams, you are able to buy it. Faira also providers home buyers with the Offer Assist program allowing you to receive 3% back on any home purchase. For the same example above, once you purchased your $500,000 home, you would receive a check for $15,000. To find out more click here.