(Updated: This article was updated Aug. 3, 2016 to reflect current mortgage information and rates.)
FICO generates the most widely used credit scores. These credit scores are based on credit reports from three major credit reporting agencies: TransUnion, Equifax and Experian. The bank or mortgage company will check your credit reports and scores and so should you.
Mortgage lenders are looking for credit scores that are at least 620 or above. Even though FHA allows credit scores starting at 520, many lenders want your scores at 620 or higher, unless you have a substantial down payment and stable work history.
Credit scores indicate to lenders how well you manage money and if you are likely to default on financial obligations. Payment history along with the amount of debt you carry will have the most impact on credit scores.
According to Freddic Mac, mortgage rates averaged 3.43 percent for the week of Aug. 3, 2016, which is slightly less than last year’s 30-year fixed rate mortgage of 3.71 percent. Mortgage rates remain fairly low but there’s no way of predicting how long they will stay that way. The market is ripe for new mortgages and even refinancing.
The following tips will help you get your credit file ready for a mortgage loan:
1. Have 12 Months of On-Time Payments. Your credit history should show at least 12 months of on time payments. Any late payments 24 months or older will not heavily count against your credit score but be prepared to explain them to a lender. If there are late payments within the last 12 months try approaching your creditor to request a goodwill adjustment. Oftentimes creditors will delete late payments if you are typically a good customer or if you can politely explain to them you are trying to get the best rate on a mortgage loan.
2. Get FICO Scores not FAKO Scores. Before you approach any lender order your credit scores. Most mortgage lenders use FICO credit scores, which may be different than the credit scores you get through credit monitoring services. Websites like Credit Karma or Credit Sesame are good tools to keep you up to date on your credit history and activity but their credit scores (FAKO scores) may be very different from your actual FICO scores. Before you allow any lender to pull your FICO scores, you should know where you stand to avoid any surprise. Order real credit scores at myfico.com. The full 3-bureau report will include your mortgage-based FICO scores used by many lenders.
3. Do Not Close Paid Off Accounts. Consumers will often pay off accounts to get rid of excess debt before applying for a mortgage. This is great but do not close paid off accounts because it may affect your average age of accounts. Having older credit accounts reporting in your credit files helps credit scores.
4. Public Records. Judgments, tax liens, foreclosures and bankruptcies will have to be explained to the lender. Any unpaid judgment or tax lien will be required to be paid. A foreclosure or bankruptcy will not prevent you from getting a mortgage but they should be at least 2-3 years old.
5. Collection Accounts. The best approach to any collection account is to have it deleted from your credit report. If the collection account is 48 months or older it should have little impact on credit scores but a lender may still require it paid. If you have some extra cash it is best to approach the collection agency and request a pay for delete. They may not always agree and if that is the case request a “paid” notation instead.
6. Charge-Off Accounts. As with a collection account the best approach is to request the account be removed in full as a condition for payoff. The problem with charge-offs is that some creditors do not report the charge-off on a monthly basis – So you may have a charge-off that last reported in 2008. But once you pay it off, the creditor updates the date of last activity which makes the charge-off look more recent. This can actually hurt your credit scores. Eventually your credit scores will recover but it will take several months as the charge-off ages. Negotiating an actual removal of the tradeline avoids this scenario.
7. Student Loans. If you have multiple student loans speak to your lender about consolidating them into one loan to reduce total student loan payments. If your loans are not consolidated, the lender will use the information from your credit reports which will result in higher student loan payments. This can affect your debt to income ratio. Avoid any student loan delinquencies, especially in the most recent 12 months of applying for a mortgage loan. Any student loan that is currently deferred should have documentation so the lender will not calculate a payment obligation If a payment letter cannot be obtained, the lender will use 2% of the principle balance to determine appropriate payment obligation for qualifying for a mortgage. Only FHA loans omit student loan debt from lender’s qualifying ratios if it is deferred for 12 months or longer.
8. Credit Cards. Having multiple credit cards is not a problem with lenders – But having multiple credit cards with balances is. No matter the number of credit accounts you have, there should be no more than 2 that carry a balance. By no means should you apply for a mortgage loan while carrying a balance on all of your credit card accounts. Not only will your score be lower, lenders will view you as high risk. High utilization is a no-no if you want high credit scores. Even if you have only 2 credit cards with balances, those balances should be 10 percent or less of your available credit limit. That means if the credit account limit is $5000, the account balance should be $500 or less.
9. New Credit. Whatever you do, never apply for new credit while working with a mortgage lender. Want to see a mortgage lender blow their top – apply for credit during the mortgage loan process. Want to shoot yourself in the foot – apply for new credit while trying to get a mortgage loan. It may be tempting to purchase new furniture or appliances for your new home but wait until the ink dries on closing escrow documents. Any change in your credit score during the mortgage application process can result in a denial.
10. Multiple Mortgage Loan Applications. Worried about hurting your credit scores if you shop for a mortgage? You’ll be relieved to know that mortgage-related credit inquiries in the prior 30 days are ignored when calculating FICO scores. After thirty days of multiple mortgage-related inquires, those inquiries will be counted as one single hard inquiry in your credit files.
11. Show Stability. Show evidence of steady employment for a period of one to two years. Have a bank account, preferable checking and savings, in good standing. Have a utility bill in your name at your current residence. All of the above show stability and lenders like borrowers who can demonstrate a stable financial foundation.
12. Hold off on that new car. The cost of financing a car includes not only monthly loan payment but also fuel, maintenance and insurance. When applying for a mortgage loan an underwriter is going to take into consideration how much of your household income is allocated towards an auto loan. It should not exceed 15 to 20 percent. The lure of a new car can get in the way of home ownership if you do not have sufficient income.
13. Consider FHA for Low Credit Scores. For consumers with low credit scores or damaged credit, FHA loans may fit the bill. An FHA loan insures the lender against default, making lenders more willing to work with low credit scores. FHA loans do require a 3.5 percent down payment and borrowers will have to pay a 2.25 percent mortgage insurance premium up front along with a monthly premium for as long as the loan is kept. FHA will give buyers with damaged credit a chance to own a home. FHA requirements for 2015.