When it comes to purchasing a home, one of the things lenders weigh highly in their decision is your credit score. Your credit score is a financial report card that reflects your creditworthiness and ability to manage debt responsibly. Your credit score is made up of a few things. While a less-than-ideal credit score might feel like an insurmountable obstacle, the good news is that it’s never too late to start improving it. Many people have had bad credit at some point in their lives.
Taking proactive steps to improve your creditworthiness can open doors to more favorable mortgage options, lower interest rates, and essentially your dream home. This blog will explore average credit scores, the minimum score needed to purchase a home, and practical dos and don’ts to help you boost your credit score.
Average Credit Scores
According to the three credit bureaus, Trans Union, Equifax, and Experian, scores range from 300 to 850. 850 is the best, and the average is approximately 700. Here is how credit scores are generally broken down:
Poor 300 to 579
Below Average 580 to 699
Good 700 to 740
Very Good 740 to 799
Excellent 800 to 850
Minimum Credit Score to Qualify for a Mortgage
While a 600 score is considered below average, purchasing a home or refinance is approvable. While a 600 score will not earn you the best rates, having a good income, assets, or down payment will make the process easier.
For example, Doug and Beth are considering buying a home with a credit score of 605. However, they have great jobs and are putting down 15% of the purchase price of their home. Their larger down payment and good income will help offset the lower score.
Things to Do to Improve Your Credit Score
Get a copy of your credit report. The 1st step to take when improving your credit is to understand yours by getting a credit report. They are available, at no cost, from one of the bureaus, like Trans Union, Equifax, or Experian. Even if you believe it’s low, this helps you know the issues you must tackle.
Once you have a copy of your report, you will need someone to help you understand it. You can consult a mortgage loan officer here at Homestead Financial Mortgage. There are places on the report that give any creditors’ contact information. This helps start the process of addressing items in need by simply understanding what’s on your report.
Settle old collections, which affect credit going from newest to oldest. Start by paying off the newest collections, as older collections occasionally stop reporting. There is little to gain in paying for an old collection unless you’re down to the last few items to address.
You can also negotiate a settlement on collections. Collection agencies work on commission, so negotiating a lower balance in exchange for payment quickly can often work in your favor. It is important when negotiating payoffs to request that they report your debt paid in full and remove it from your report.
Pay the balance of your credit cards down, but you don’t necessarily need to pay them off completely. Part of your credit score involves how you manage revolving accounts and pay them back over time. A good rule of thumb is never to carry a balance of more than 1/3 of your total limit. For example, if you have a credit card with a limit of $3,000, then keep your balance less than $1,000.
Another reason to keep your balance low is that revolving accounts have very high-interest rates. A high-interest rate combined with a high balance can put consumers in a place where it could take up to 20 or more years to pay off their debt by only making minimum payments.
Apply for a secured credit card. Revolving accounts are mostly unsecured, so they often turn down people with low scores. If that is happening, then apply for a secured credit card.
Capital One and Discover have cards that require security deposits. They have helped our borrowers improve their scores enough to buy a home. A secured credit card requires a check to be sent in advance, acting as a deposit against the line of credit.
While it may seem odd to get more debt, you can demonstrate positive credit behavior by using this card responsibly, making timely payments, and keeping your credit utilization low. Over time, these responsible habits can help establish a positive payment history and boost your credit score.
Set up auto-pay to help pay your accounts on time. If the idea of autopay is scary, then start slowly to pay the minimum on your revolving balances. This will help avoid any late payments.
Timely credit card payments showcase your reliability and responsible financial management to lenders and credit bureaus. Consistently making payments by the due date helps maintain a positive payment history, which is a large factor in your credit score. A strong payment history reflects your ability to meet financial obligations and signals to potential lenders that you are a trustworthy borrower. Late payments can stay on your credit report and negatively affect your score for up to 7 years.
Find a good, licensed Mortgage Loan Officer (MLO) to devise a plan. A good mortgage lender helps to guide each borrower to qualify for a mortgage. This will include providing guidance on what accounts to pay down, what accounts to pay off, or when to get new accounts. The loan advisors at Homestead Financial can take a deep dive into your credit, and our tools can help us see what changes will make the most significant improvement to your score.
For example, we reviewed a customer’s credit and suggested that they pay down a credit card. This small effort improved their credit by 45 points!!!
Things to Not Do When Improving Credit
Don’t engage in excessive balance transfers. Opening new account after new account won’t improve your score. If anything, it will hurt due to the limited history on those cards and the number of inquiries to your credit.
Don’t max out your credit cards and keep them there. Maxing out refers to using up the full amount of credit available. You should be ok with paying the balance down quickly, but don’t make this a habit.
When credit cards are maxed out, it indicates a high utilization rate, which suggests a reliance on credit and potential financial instability. Lenders may view this as a risk, as it implies an increased likelihood of missed payments or an inability to handle additional debt. Secondly, maxing out credit cards reduces the available credit limit, further exacerbating the credit utilization ratio. Lastly, carrying high balances on credit cards and making only minimum payments can lead to accumulating interest charges, increasing the overall debt burden, and making it more challenging to pay off the balances promptly.
Don’t have excessive inquiries on credit. Pulling your credit reports too often in a short period of time, even if for different reasons, will lower your score.
For example, Doug and Beth applied for a credit card, a car loan, and a home loan within 30 days. This dropped their score because these inquiries happened in such a short time frame and were for different reasons.
You can have credit pulled for the same type of loan multiple times but not for different loans.
Multiple mortgage companies can check your credit without affecting your score when applying for a mortgage. The bureaus realize you are shopping for a mortgage.
Don’t stop working on improving your credit when you get your score to 600. The higher your score, the lower your interest rate on your mortgage application. There is a difference between a good and a great credit score. While 600 is the minimum credit score needed, the best mortgage rates happen to be when your score gets above 780.
What should you do?
A great starting place would be getting a credit report from a free service provider or a good mortgage lender. A good lender will help you define a plan to improve your score. They will also complete the preparation process required to purchase a home.
You should make it a habit to keep an eye on your credit score, checking it quarterly or even monthly to ensure that there is nothing on it that you don’t know about. And if you’re thinking of buying a home, it’s never too early to start planning. If there are any surprises or problems with your report, it’s best to involve an expert that can help so you have time to resolve past issues to ensure a smooth mortgage process.