Being prepared and handling credit the right way before applying for a mortgage can literally save you thousands of dollars.
You may be able to qualify for a mortgage with a credit score as low as 600. However, your rates and terms will be much more favorable if your credit score is over 670. Your credit score can affect your monthly mortgage payment for years to come. Handling your credit accounts the right way before applying for a mortgage will help you negotiate better interest rates and terms. Also, it will increase your chances of getting an approval.
Here are some of the most important steps you can take to achieve better interest rates and higher chances of approval before applying for a mortgage:
- Prepare at least 1 year before you apply for a mortgage
- Make full on-time payments & pay as much debt as possible
- Check your credit reports
- Correct any error you found on your credit reports
- Keep a low debt to income ratios
- Don’t apply for new credit accounts just before a mortgage application
- Don’t apply for another mortgage shortly after they reject your application until you resolve the issues
- Avoid making big purchases like a car or furniture until you buy the home
Start Your Preparation Months Before You Apply for a Mortgage
Improving your credit scores and credit reports is not a fast process. Having good credit is a long game. Don’t expect great results if you start handling your credit right a few months before you apply for a mortgage.
The earlier you’ll start to adopt good credit managing habits the better it will be for your mortgage application.
Depending on your current credit score standing, it can take more than a year to see actual results.
Also, it takes time to successfully fix any errors on your credit reports. It can take 30-45 days if you manage to fix an error on the first try. Otherwise, it may take much longer depending on how complicated your errors are.
Make Full On-time Payments & Pay as Much Debt as Possible
When it comes to handling credit, making full on-time payments is the most important advice.
This is because Payment History affects your FICO credit score by 40%. There’s no doubt that paying all your bills on time will make lenders trust you more.
Remember that a late payment can stay on your credit report for seven years. It doesn’t affect your score that much if it’s old.
In addition, you should try to pay off as much debt as you possibly can before applying for a mortgage.
Obviously, having too much debt is not a good signal for your potential lenders.
Check Your Credit Reports
Checking your credit reports frequently is an essential habit for every responsible borrower. If it’s not already your habit, you should check your credit reports as soon as possible.
You might find errors you’re not responsible for, but they can deduct points from your credit score if you don’t take action.
For example, you might discover fraudulent activity such as identity theft or errors like the same debt reported twice.
Further, some positive information might not be recorded under your name if your personal details are wrong.
It’s recommended to check all of your three credit reports from Equifax, TransUnion, and Experian. You can obtain each of them for free (once a year) through AnnualCreditReport.com.
Mortgage lenders use what is called a Tri-Merge Credit Report which will show them all three bureaus in one easy to read report.
Correct Any Error You Found on Your Credit Reports
Obviously, the next step would be to correct any errors you’ll find on your credit reports.
While you’re checking your credit reports, make sure:
- There are no negative inquiries you’re not responsible for
- All personal details are correct
- All account details (payments) are correct
- Your positive inquiries (such as full on-time payments) are reported as intended
If you spot any errors, you’ll probably need to contact each of the credit reporting bureaus that have reported the error. You’ll have to send them a letter and let them know why they should remove the error.
If they don’t accept your dispute, you’ll need to contact the creditors that have reported this error.
How Do You Know How Much House Can You Afford?
Debt to Income ratios and your down payment are the main factors in determining how much home you can afford to purchase. Of course rates can affect this figure but you can figure
Debt to income ratios will tell a lender how much you have in debt payments in relation to how much your gross income is. If you make $5000 a month in total gross income your maximum mortgage payment should be no more than 28% of that income. Your total debt service should be no more that 36% including your new mortgage payment.
Mortgage lenders also like to see that you have a little skin in the game, so having a down payment is also important for you to have, There are many down payment assistance loans for first time home buyers though. Programs like FHA and USDA loans offer low or no down payments.
However, there is a trade-off with a low or no down payment home loan. The home you purchase will be scrutinized more and you will pay higher interest rates and/or private mortgage insurance to insure the risk of default. This will naturally make your payment higher so you may have to settle for less home.
Keep a Low Credit Utilization Ratio
Your credit utilization ratio is the percentage of your credit owned divided by your maximum credit limit.
For instance, if you owe $200 and your maximum credit limit is $1,000, your credit utilization ratio will be 200/1000 = 0.2 or 20%.
This percentage is also among the most important credit-scoring factors. Creditors like to see a credit utilization ratio below 30%.
It shows that you know how to manage credit responsibly and you don’t overspend. This will also help you get your score in line.
On the other hand, the maxed-out credit accounts trigger a red flag for your potential lenders.
Don’t Apply for Other Credit Accounts Just Before a Mortgage Application
When you apply for a new credit account, creditors will add a hard credit inquiry on your credit report. This will deduct a few points off your credit score. Applying for too many credit accounts in a short period of time will deduct many more points though.
This behavior will not only lower your credit score but it will also make your lenders trust you less.
Don’t Apply for Another Mortgage If You Are Denied
For the same reason, you shouldn’t apply for another mortgage if they reject your first application.
It can make your situation even worse.
Instead, try to understand why they rejected your application and think about how you can fix these issues.
Often, your lenders will let you know why they rejected your mortgage application. When there’s a huge issue you need to fix, applying for another mortgage will probably have the same results.
Usually, if there is another loan product you qualify for, the lender will tell you. If you are working with a bank you can call other mortgage professionals, known as mortgage brokers, and explain your situation and see if they have a product that fits. They often have programs that banks do not offer. But you really need to have a clear understanding of why you were denied to know if they have a potential product.
They will certainly have to pull your credit again which is always going to affect your score negatively.
Avoid Making Big Purchases Until You Own the Home
Your creditors will probably check your bank statements until the last minute before they sign the mortgage.
Making big purchases using credit (such as buying a car or new furniture or electrical appliances) will not work in your favor.
Sometimes, people will go out to buy furniture while they are still in the process of purchasing a home. This can be a terrible mistake because mortgage lenders will pull your credit a second time right before you are ready to close the loan. This can cause your loan to be declined even though you were once approved because they will add the new monthly payment into your debt to income ratios.
The less you owe the lower interest rates and higher chances of approval you’ll get.
What Do Lenders Check Before They Approve Your Mortgage Application?
Every lender has its own process for approving or rejecting a mortgage. However, all of them will check the following criteria:
- Your payment history: Obviously, your lenders will want to know if you’re a responsible borrower and if you use to pay your bills on-time. If you have many late payments, they will probably ask you for explanations. Your payment history affects drastically your credit score too.
- Your Income – You will want to know how much you can afford. They will need the following items that apply: 1099, W-2, Pay Stubs, Tax Returns with all schedules. If you are self-employed you may be required to include additional information like business bank statements and an additional year of tax info.
- Your Reserves – This is how much you have in savings. Some loan products require a set number of mortgage payments in your account. Others do not. But you may be offered favorable rates and terms if you have more in savings. You may need to provide all bank statements and financial statements that are being used to approve the loan. This can include retirement accounts and investment accounts.
- Recent credit applications: They’re also known as hard credit inquiries and they happen every time you apply for a new credit account. You shouldn’t have too many hard credit inquiries before you apply for a mortgage.
- Negative public records: Of course, major derogatories will greatly affect your lenders’ decision to approve your mortgage. Records like bankruptcies or collection accounts are negative signs. They negatively affect your credit score too but they less powerful the older they are. Lenders will often require that any collections and judgments are paid before they will approve your loan, even if they are older.
What are Lender Guidelines?
Lender guidelines are a set of rules that the banks have in place to protect them from default. These are a set of criteria that the borrower must have in place when applying for a mortgage and getting approval.
There are several different loan types with a range of guidelines that are based on previous borrower behaviors.
For example, a conventional Fannie Mae mortgage requires that you have a 620 credit score for a fixed-rate loan. If you have a credit score of 640 you can qualify for an adjustable-rate loan. Your debt to income ratios should be no more than 28% of monthly income on housing expenses, and no more than 36% on debt servicing including mortgages and car loans.
Here are some examples:
If your total monthly gross income is $10000 per month then your mortgage payment should be no more than $2800 per month and your total debt as reported on your credit report should be no more than $3600 per month including your new mortgage.
If your credit score is higher and you have enough payments, called reserves, in your savings then you may be able to get what is called an exception and be able to qualify with higher debt payments.
Some other guidelines to consider are sourcing and the amount of your down payment, how much you have in savings, how long your credit history is. There are alternative credit guidelines as well for first time home buyers with loan products like FHA. An FHA loan will allow for alternative credit sources for those that are credit invisible, like rental and utility payments.
There are several different loan products on the market to accommodate potential home buyers. Your mortgage professional will be able to assist you in choosing a loan product you can qualify for and meets your needs. This why it is important to start early so you are not placed in a loan that costs more money.
If you start early enough you can create the best borrowing scenario for yourself so that you get the best rates and terms.
Facts About Your Credit Before Applying For A Mortgage – Summary
Applying for a mortgage is an important decision you shouldn’t rush. If you decide to do so, you should start preparing for at least a year to achieve better interest rates if your credit situation is subpar. You will want to reach out to a mortgage professional to do a pre-wualification to see where you stand.
The most impactful tips you should follow are making full on-time payments and paying off debt. You can’t ignore checking your credit reports and must fix any errors you spot as well.
Keeping a low debt to income ratio and limiting your credit account applications will help you too.
Of course, you should avoid making big purchases until you finally own the house. Even after you get the mortgage, you’ve better to create and follow a budget plan so you can pay your debt as soon as possible rather than sinking into more debt.
If you’ve already made your decision to apply for a mortgage, you have nothing better to do than follow the above-mentioned tips!
Facts About Your Credit Before Applying For A Mortgage FAQs
Lenders will usually check the last 6 years of your credit history to make their decision.
As for any other credit application, creditors will always check your FICO score. However, your FICO score might be different on each credit reporting bureaus if you haven’t checked your credit reports in a while.
It can take from 1 to 14 days, depending on how complicated your situation is.
You’ll need a credit score of at least 620 for conventional loans. However, you can qualify with a lower score for VA, USDA, and FHA loans. To get the best interest rates for a mortgage you’ll need at least a credit score of 740 or above.
At least 1-2 years depending on your situation. The way you handled credit the past year affects your credit score and reports drastically. It also takes time to fix your credit score, so the earlier you start the better results you’ll have.
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