How to Improve Your Credit Score to Buy A House
You want to buy a house soon, but you are not sure if you have good enough credit to get a mortgage. Fortunately, there are ways to improve your credit score to qualify for a home loan at competitive rates. And if your credit score is on the low end because you’re a loan novice or have had a string of financial missteps in the past, don’t worry: it’s also possible to repair damaged loans.
Why you should improve your credit score
Even if you currently meet the mortgage lender’s minimum credit rating requirements, you should aim for as high a credit rating as possible. That’s because lenders decide your creditworthiness largely based on your FICO scores, and the terms of your loan are based on your creditworthiness.
The lowest interest rates are typically reserved for the best credit-worthy consumers, and as little as a percent lower interest rate can result in significant interest savings over the life of the loan. You also get a cheaper monthly payment.
To illustrate, suppose you are looking for a $350,000 30-year, fixed-rate mortgage. If your credit score is 740 and you qualify for an interest rate of 6.5 percent, you’ll pay $2,212 per month (principal and interest only) and $446,583 in interest over the life of the loan. However, if your credit score is 650 and the lender offers you a 7.5 percent interest rate, your monthly payment increases to $2,447. In addition, the interest you pay for the life of the loan is $531,258.
There are general average interest rates for the various FICO scores — or, strictly speaking, FICO score ranges. (Of course, it can vary by lender, and other factors beyond your credit score can also influence their decision). The average interest rates that loan applicants are eligible for based on their FICO score are as follows:
| 620 to 639 | 7.97% |
| 640-659 | 7.42% |
| 660-679 | 6.99% |
| 680-699 | 6.78% |
| 700-759 | 6.6% |
| 760-850 | 6.38% |
Creditworthiness Basics
Before you take the next steps to improve or restore your credit score, it’s important to understand how your credit score is calculated. That way, you know which areas of your credit profile to focus on.
The FICO credit scoring model, which 90 percent of lenders use to make credit decisions, has five components:
- Payment history: 35 percent of your credit score
- Amounts owed: 30 percent of your credit score
- Credit history length: 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 rating
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 reports and identify negative elements affecting your credit score so you know what to focus on first. Also, dispute any errors you find with the credit bureaus and creditors to have them corrected.
Below are some additional steps you can take to get your credit score in the right direction.
Reduce your debt
First things first: Get out of debt.
- Pay all your bills on time. A single missed payment can drop your credit score by several points if the account is 30 days past due. Late payments stay on your credit report for seven years, but the negative impact diminishes over time.
- Bring all your overdue accounts up to date. If accounts are delinquent, bring them up to date to avoid additional negative credit reports. You can also contact the creditor or lender and request a payment arrangement to get the account(s) back in order.
- Reduce your revolving debt balances. The amount of fees you have on a credit card in relation to the total line of credit is called the credit utilization ratio or rate. For example, if you owe $15,000 on all of your credit cards and the total limit is $30,000, you have a 50 percent credit utilization rate. Ideally, the balance on your credit card accounts should not exceed 30 percent of the card credit limit. So in our example, you want to reduce the total amount you owe to $9,000 or less to improve your credit score.
- Consider a debt consolidation loan. This type of debt helps improve your credit utilization by consolidating your debt into a single loan, preferably at a lower interest rate. They also simplify the repayment process and could save you a bundle in interest.
Increase your credit
Reducing your debt is good, but you can also do things the other way—by increasing your credit.
- Request higher credit limits. Some credit card companies allow you to request a credit limit increase without affecting your credit score. If approved, your credit usage will decrease unless you make further purchases with the card. A drop in your loan utilization rate could also mean good news for your credit score.
- transfer credit. If you get an offer on a credit card that offers a zero percent interest rate (usually for a set period of time, say 20 months), you should transfer the amount you owe on another card to that card — specifically if the old card has a high APR. Yes, you will temporarily hurt your credit score, but you will also increase your credit utilization rate. It’s also easier to pay off old debts because there’s no interest. Just give it a try before the zero percent offer ends.
- Become an authorized user. Ask a relative or friend to add you as an authorized user to accounts with exceptional payment history and low usage rate. The account will appear on your credit report and could boost your credit score.
other movements
Other strategies can add some shine to your credit score, especially as the time to apply for a mortgage approaches.
- Don’t close old credit accounts. Even if you pay off the balances, closing credit cards you’ve had for some time will cause your average credit account age to drop, which could hurt your credit score. They could also negatively impact your credit utilization rate.
- Don’t apply for a new loan. Aside from the balance transfer deals, avoid signing up for new credit cards or taking out new loans of any kind. Every time you apply for a loan, a tough loan request is generated, which can result in a slight drop in your credit score. Although the effects are temporary, mortgage lenders frown on opening new credit accounts just before or during the application process.
Minimum credit ratings by credit type
Mortgage lenders use your median FICO score from the three major credit bureaus (Experian, TransUnion, and Equifax). So if your score is 660, 680 and 710, 680 is the number used to determine the credit terms you qualify for.
Different types of mortgages have different minimum amounts. Here are minimum credit scores by loan type:
- Conventional credits: 620
- FHA Loan: 580 (with a 3.5 percent down payment) or 500 (with a 10 percent down payment)
- USDA loan: 640
- VA loan: 620
- Jumbo loan: 700
Keep in mind that some lenders have overlays or specific guidelines that are more stringent than the lending rules established by the FHA, USDA, VA, Fannie Mae, and Freddie Mac.
Ideally, you aim for a credit score of 760 or higher to qualify for the best interest rate. But if your score is slightly lower, you could still be approved for a home loan with competitive rates.
Next Steps
You should take the steps to improve your credit score as much as possible before you start looking for a home. The longer you have a strong score, the better as far as lenders are concerned.
When you’re ready to apply for a mortgage, research lenders and get your best options pre-approved to compare home loan offers. You may find that one offers a far more competitive deal than the other, or your credit history may require more work to qualify for better interest rates.
But if your credit is good and the loan offers are working for you, hire a reputable real estate agent to help you navigate the home buying process.