Look, we’re not going to sugar coat it: Your credit rating is important if you want to buy a home. That three-digit number has quite a weight in the mortgage process. It’s used to determine your interest rate, not to mention your eligibility for a home loan.
The good news is you don’t need a perfect credit score to buy a home, but you should work on improving your score as much as possible if you want to get the best deal on your mortgage.
Why Your Credit Score Matters
Before we delve into the question of how you can improve your score, it’s probably a good idea to cover why your credit score is so important to buy a home.
So here’s the deal: your credit score is usually tracked by companies called “credit bureaus.”
Credit scores range from 300 to 850 and provide a general gauge of your track record in managing and repaying debt. The debts that affect your credit score can include credit cards, car loans, student loans, medical bills, and personal loans, among others.
A good credit score — typically anything over 700 – shows you are paying your bills on time every month, and are unlikely to default on your payments.
This is music to a lender’s ears because ultimately, they are taking a financial risk to lend you money, especially if it is a mortgage loan that is hundreds of thousands of dollars.
For this reason, it is crucial to get your credit rating as high as possible before applying for a mortgage, and you must leave it there throughout the lending process. You want to show your lender that you will be an upright borrower and that you can count on repaying your debt.
As well as attracting lenders with a good credit rating. Getting a better rate on your mortgage will save you thousands over the term of your loan. Typically, borrowers with a credit rating of 740 or higher have the lowest mortgage rates available.
In the meantime, a lower credit score will result in a higher mortgage rate, which unfortunately means that you will pay more for your home over time. Not only that, but a lower score will likely require a bigger down payment on your new home.
What Makes Your Credit Score
Okay, you know your score is important, but do you really know what it says? Few of us really think about how our score is calculated, but understanding how the sausage is made is crucial if you want to make improvements.
No financial institution will tell you exactly how to calculate your credit score, but according to Experian, the calculation goes something like this:
- Payment History: 35Percent of Your Score
What it’s all about: This part of your credit score reflects – you guessed it – your payment history. If you pay off your debt on time each month and cover at least the minimum amount, that part of your score should be in relatively good condition.
- Use: 30Percent of Your Score
What matters is how much credit you are currently using compared to what you have available. The less credit you are currently using, the better your credit score. Let’s say your credit card has a maximum credit of $10,000. If your credit is relatively low, say $1,000, it will affect your credit score better than if you are using $8,000 of your maximum credit.
- Lenght of Credit History: 15 Percent of Your Score
What comes out: Creditors want to see that you have a solid long-term history of debt repayment. Remember, a lender can’t say much about whether you will pay your mortgage on time if you look at the 3-month data, so the longer your credit history, the better.
- Credit Mix: 10 Percent of Your Score
Interestingly, the credit bureaus consider different types of debt to be a good thing. They show that you can handle different types of loans such as car loans, student loans, credit cards, etc.. And that you will pay them back according to the terms of the contract.
- New Credit: Ten Percent of Your Score
The upshot is that opening a new line of credit can have a negative impact on your score for a while. Therefore, you should avoid taking out new loans in the months leading up to your mortgage. Remember – the credit bureaus will reward you for longer-term loans. Be very careful when you take out new debt while shopping at home.
Be sure to keep these elements in mind as you work to improve your credit score. They can help you prioritize your time and money!
Now that you have a basic understanding of what’s in that magic number known as your credit score, we’ve rounded up the 6 most important tips you need to know to make you financially fit to buy a home.
- Check Your Credit Reports
The first step to improving your credit rating? Knowing what to expect. That means attracts your credit reports from all major bureaus and going through each with a fine combination.
Remember that you are entitled to get your free credit reports once a year from any of the three major credit reporting agencies. Use them! You can get your free credit reports at Annual Credit Report, a government-run website.
Skip Tools For Estimation
Certainly, you can always receive a free estimated credit score from companies. But it is best to see your official credit reports from the big three credit institutions.
We have seen it far too often: a home buyer will apply for a mortgage based on a score they found on a credit rating tool, and then learn the difficult way – after applying for a mortgage – that their true score was lower. Don’t let that happen!
If you work from your official credit reports, go into the mortgage process with your eyes wide open.
- Identify And Fix Problems With Your Credit Reports
Now that you have your credit reports at hand. You can focus on fixing the points that bring your score down.
Check each of your reports line by line. Check that all information is correct, and mark all accounts or line positions that are negative or inaccurate.
Always Challenge Credit Reporting Errors
Did you know that credit reporting errors are extremely common? According to recent government data, more than a fifth of Canadians has read material: fairly large errors in their credit reports.
The good news is that you have a right of recourse – every consumer has the right to challenge an error in their credit report, and both creditors and credit reference agencies have a legal obligation to correct your report if an error is found.
How To Challenge An Error in Your Credit Report
If you see an error in your report, you should dispute it as soon as possible. To do this, send a letter of appeal to the credit institution that made the mistake and ask the government to remove it, compiling a practical template for appeal letters that you can use.
The credit bureaus are legally obliged to investigate an error within 30 days and to correct the error if the creditor is unable to verify the accuracy of the disputed item.
You are also obliged to send you the results of the investigation and a copy of your credit report if any changes have been made. You should also send a letter of appeal to the creditor who made the mistake and provide the same documents that you sent to the three credit bureaus.
One Caveat: if you dispute an error in your credit report, credit bureaus will list the account as “disputed” in your reports, a dispute that is visible to anyone who sees your credit report.
If you a challenge account at the same time as applying for a mortgage, there may be funding delays. Most mortgage lenders will cancel your loan until disputed accounts have been cleared. That is another reason to give yourself plenty of time to repair your credit before applying for a mortgage.
- Settle Outstanding Debt in Debt Collection
If you have outstanding debt that has gone to debt collectors, they could significantly reduce your bills.
Call the debt collection agency and tell them that you want to “pay to delete” the debt, which means you pay what you owe in the account and they will erase the negative point from your credit report.
Make sure to note down all the information from your call. Who you have spoken to and their contact information, as well as any negotiations you have come to. Finally, make sure you receive a letter from the agency confirming that you have paid the balance and the agency will remove the debt from your credit report.
You can use this as evidence for the credit bureaus if, for any reason. The negative account remains in your credit reports.
Pro tip: You can frequently negotiate the volume you owe to a collector. But always confirm that the collector will actually delete the negative account from your credit reports before you to make a deal.
- Repay Balances
Remember how credit utilization accounts for a whopping 30% of your credit score? One way to quickly improve your credit quality is to reduce your credit utilization.
Do you have a credit card balance that you actually wanted to payback? Now is the time! The lower your utilization rate until you take out a mortgage, the better.
Experts suggest keeping your utilization below 30% to protect your credit score. In other words, you should use less than 30% of your available credit. Consider this step as a free space in your financial profile for your home loan.
The good news is that this tactic can dramatically and quickly improve your score.
- Avoiding Further Debt
While you are preparing to buy a home, and even as you go through the process of getting a mortgage. It is essential that you do not take on any more debt.
For example, opening new debt accounts: taking out a car loan will negatively affect your credit score. So it is important to wait until you have closed your house to consider a new loan.
Pro Tip: Even if you have already applied for a mortgage and approved by your lender, you could be putting your home loan at risk if you take on additional debt before the deal is complete. Mortgage lenders monitor your loan throughout the entire lending process, which takes an average of 45 days nationwide. Changes could delay or even upend your financing.
- Do Not Close Accounts
After all, it’s best not to close credit accounts while applying for a mortgage. There’s a lot of debate about whether closing unused accounts harms your credit. But, given that your score is partly based on your mix of credit and loan term. It is probably best not to get involved with anything so close to taking out a home loan.
Keeping the account open but inactive should not harm your credit. But closing an account so close to applying for a mortgage could cause concern on the lender’s side. If you really want to close the account, wait until you have closed your new home.
Give Yourself Time
It is ideal to start the process of carrying out and repairing your loan long before you apply for a mortgage.
Give yourself at least 3 to 6 months for slight credit repair. If you have significant credit problems, you will probably need at least a year to see significant changes.
The truth is that enhancing your credit score takes time. It can take weeks, or even months, for your assessment to reflect positive changes you are making. Don’t expect to be able to repair your credit overnight. Give yourself enough time to complete this important step in home purchase.