Getting ready to shop for a new home? Whether it’s your first home or your tenth, it’s always a good idea to clean up your credit score before you shop.
Why? Because the higher your score, the better interest rate you’ll get on your new home. And when you’re talking about a purchase over hundreds of thousands of dollars, even a single percentage point in interest makes a huge difference.
Case in point: the base payment (not including property taxes or insurance) on a $200,000 30-year mortgage with a 4% interest rate is around $954.83 according to this calculator, and you’d pay $143,739 in interest if you paid down the mortgage over the allotted time. Bump up the interest rate to 4.5%, and the monthly payment would be more like $1,013. This one, though, would cost a total of $164,813 over 30 years. That’s a $21,000 difference!
Since even a few points’ worth of credit can impact your mortgage interest rate, you’ll definitely want to walk through these three steps before shopping for a mortgage:
Step 1: Make all payments on time
Each credit bureau has a different proprietary formula to calculate credit scores. But they all operate on a similar breakdown The most important piece of your credit history is your payment history. On-time payments are great. Delinquent payments will wreck your credit score faster than anything else.
According to the Consumer Credit Research Institute and the Urban Institute, about 5.3% of Americans have an account at least 30 days late on a credit card or non-mortgage debt account.
Once a debt goes 30 days or more past due, most creditors will report it to the credit bureaus. Though some will offer a reporting grace period of 60 or even 90 days. But it’s best to avoid overdue payments altogether.
If you struggle to make payments on time, every time, use these tips to ensure you have no late payments before mortgage shopping:
- Make a cash flow sheet. Use a calendar to write down when and how much you get paid each month. Then, write down the due dates and payment amounts of each payment. This visual will help you see when you’ll need to make each payment that month.
- Pay ahead of time. While most creditors won’t report an account delinquent until it’s 30 days or more overdue, it’s a good idea to get into the habit of paying early. Mail time and processing issues can sometimes make your payment late – even if you technically sent it on time.
- Get a month ahead. If possible, the best way to avoid late payments is to stay ahead of them. On set payments, like your car payment, pay two months at once. Then, you’re always a month ahead, and you can pay the bill on your own timeline each month without being late.
Step 2: Pull your report, and clear up inconsistencies
Before you shop for a mortgage, you’ll definitely want to pull your credit report. You can do this at www.freecreditreport.com. You’re legally entitled to one copy of your credit report each year from each of the three major credit bureaus – Equifax, Experian, and TransUnion.
Since the bureaus sometimes operate off of different information – or make different mistakes – on your report. So before you get a mortgage, pull all three reports. (Even if you have to pay a few bucks to do it!)
A 2013 FTC study showed that 5% of consumers had a major credit report error with one of the three bureaus, and one in five consumers had at least a minor credit report error.
With this statistics, it’s clearly worth checking all your credit reports before applying for something as large as a mortgage!
When you pull the reports, check to ensure that all the basics are accurate. Is your name spelled correctly? Is your current address correct? Then, check to ensure that all your financial statistics are properly reported. Are all your open accounts represented? Is the balance and payment information correct?
If you find a mistake, use the credit bureau’s online dispute process to clear up any issues well before applying for a mortgage. Remember, it can take weeks or even months to clean up issues on your credit report, so give yourself plenty of time.
Step 3: Pay down credit card debt
Your credit score is designed to measure, in essence, how well you use debt. So having absolutely no debt means that you have no credit score – not a great situation for buying a home. But having too much debt, especially credit card debt, isn’t good either.
Next to your payment history, your credit usage is the biggest piece of your credit score. This is basically a measure of how much credit is available to you, and how much of that credit you’re currently using.
In other words, if you have a combined $100,000 credit card limit but are only carrying a $5,000 balance, you’re in great shape. But if you only have $5,500 of available credit, that $5,000 balance would be a huge credit score no-no. It’s the same amount of debt, but it’s going to count against you rather than for you.
The ideal here is to pay down your credit card balances every month, so that you’re effectively using 0% of your available credit, whatever that may be. But if you can get your debt-to-credit ratio down below 50%, you’ll be in fairly good shape.
So if you’re currently carrying high credit card balances, devote any extra resources to paying down those debts as much as possible before applying for a mortgage.
Depending on your particular credit history, you may want to take some additional steps to brush up your score before applying for a mortgage. For instance, in some cases, opening a new type of account is actually beneficial to your score. However, these three steps are the ones that will boost your credit score most quickly and reliably. Following them may take a few months, but the eventual savings will be well worth your while.