Purchasing a home could be one of the most important financial decisions you make. And having good credit can be especially important when you apply for a mortgage. Not only will good credit help you qualify, having higher credit scores could help you get a lower interest rate and save you thousands of dollars.
If your credit isn’t as high as you’d prefer, you may want to take some time to work on your credit before house hunting. However, even if you need to move right away, some of these steps may help you qualify for better rates or terms.
1. Review your credit reports and scores
If you haven’t already checked your credit reports and credit scores, that’s a good place to start.
You can get free copies of your credit reports from each of the bureaus – Equifax, Experian, and TransUnion – on AnnualCreditReport.com, and from some online services, such as Credit Karma or from Experian.
You can also check credit scores online for free. Unfortunately, most of the free credit scores aren’t created with the same formula that mortgage lenders will use. But they can still give you an estimate of where you fall in the score range.
If you find your score is close to the minimum required score for a mortgage (500 to 640 depending on the type of mortgage and lender), you might want to purchase copies of your credit reports with the FICO scores that many mortgage lenders do use.
Here are the names of the three scoring models, which are older versions of the base FICO score (currently on version 9. Each score is based on your credit report from the corresponding credit bureau. Lenders will usually check all three of your scores and use the middle score to approve or deny your mortgage application:
- TransUnion FICO Risk Score, Classic 04
- Equifax Beacon 5.0
- Experian Fair Isaac Risk Model V2SM
You may be able to buy these scores from FICO. But keep in mind that your scores can change at any time and they might not be the same when you apply for a mortgage.
2. Dispute errors you find on your credit reports
You also want to carefully examine your credit reports–probably with more detail and focus than you’ve ever done before. Make sure there aren’t any incorrect negative marks that shouldn’t be on your reports, as these could bring down your scores and make it harder to qualify for a mortgage.
Negative marks, also called derogatory marks, can include:
- late payments
- Accounts in default or collections
- A charged-off account
- An account that was settled for less than what you owe
- A bankruptcy.
If the derogatory mark is accurate, you may need to wait until it falls off your report on its own. This can take seven to 10 years, depending on the type of derogatory mark.
However, sometimes these marks are the result of an error. Common errors can include:
- Accounts that you didn’t open appearing on your credit reports
- Negative marks that should have dropped off your credit reports already
- An incorrect balance or late payment on your account
Even a small error, such as an incorrect balance on a collections account, should be corrected so that your credit reports accurately represent your credit history.
If you find an error, you have the right to dispute the information and ask the credit bureaus to investigate your claim and correct your reporrs. Often, you’ll need to file a dispute with all three credit bureaus to make sure that all three of your credit reports are corrected.
You can complete the process online or via mail. CreditDash can also help you analyze your credit reports for potential errors and draft dispute letters that you can send to the bureaus.
3. Pay down revolving credit accounts
Your current balances on revolving credit accounts, including credit cards and lines of credit, can be an important factor in determining your credit scores. Oaying down these balances is one of the few ways to quickly help your credit.
Focus on the ratio of your current balances to your overall credit limit.
For example, if have three credit cards with $3,000 credit limits, your total available credit is $9,000. If your cards have a combined balance of $5,000, your utilization rate is 56 percent (5,000 / 9,000 = .56).
Having a low utilization rate on each account is important, but what’s most important is keeping your overall utilization rate as low as possible. Some say to keep it below 30 percent; others say 10 percent. In truth, there’s no magic mark — but lower is better.
If you’re already paying your credit card bill in full each month, you may want to start making bi-monthly or early payments. Many credit card issuers will report your balance to the credit bureaus around when they send you your monthly statement, often about three weeks before your bill is due, and the reported balance is what impacts your credit scores. By paying down your balance early, you can make sure a lower balance winds up on your credit reports.
4. Don’t close or open accounts
Opening a new loan or credit card could lower your credit scores and may make it more difficult to qualify for a mortgage. Even if you don’t get approved, just applying could hurt your credit because it will result in a hard inquiry getting added to your credit history.
But don’t worry, when you’re ready to apply for a mortgage, you can (and probably should) apply for multiple loans to see which lender offers you the best deal. Multiple inquiries for certain types of loans, including mortgage, personal, and student loans, only count as a single inquiry for scoring if they all occur within a 14- to 45-day window (it depends on the credit scoring model).
There is an exception if you don’t plan on making on offer in the next few months or can’t currently qualify for a mortgage due to low credit scores. In these cases, you may want to open a credit card, or secured credit card if you have poor credit. Use the card for a small purchase each month and pay the bill in full to add a new, positive account to your credit history.
On the other hand, if you have credit cards open already, you might not want to close any accounts before you move. Closing an account could increase your utilization rate because you’ll now have less available credit. If you don’t want to use the account, set the card aside, or even cut it up, and then wait until after you’ve moved to close the account.
5. Continue paying your bills on time
Moving from a low to high credit score can take time. While some actions can have an almost immediate effect, such as correcting errors and paying down revolving accounts, you generally won’t see significant changes in your credit scores overnight.
If you’re currently paying down loans or a credit card balance, keep sending your payments and make sure every payment is on time. If you have a credit card that you don’t use, you may want to make a small purchase each month and then pay off the balance so the activity will show up on your credit reports.
Work on your finances in the meantime
Ideally, you can give yourself several months to a year to review your credit reports and build a history of on-time payments with your accounts. During this time, you can focus on other ways to improve your finances.
Perhaps you could try to increase your income and pay off debts to improve your debt-to-income ratio, which can also be a factor in whether a lender approves your application. Or, you can start saving up money for a larger down payment, which can also help you qualify for a mortgage with a lower interest rate.