When people start the process of buying a home, there are a lot of things to focus on: which neighborhood they want to live in, finding the perfect house, getting approved for a mortgage at a great interest rate, and then the all-consuming process of packing and moving. But before any of that happens, there is one more item that should lead off their checklist: taking care of their credit score.
While a significant portion of homebuyers still pay cash for their homes (a reported 4 out of 10 buyers paid cash in 2014!), but the majority of buyers still need to take out a mortgage loan. So keeping your credit score iup to par has some very tangible benefits during the home buying process:
• Lower interest rates,
• A greater variety of loan programs available,
• Qualify for loans with less money down,
• Your offer on a house will be seen as more favorable if you have a high credit score, giving you more leverage. During multiple offer situations and bidding wars, the seller sometimes requests additional documentation like proof of the buyer’s credit score and funds.
• But, of course, saving money when you make your mortgage payment every month is the real benefit. Even a credit score increase of a few points may help you qualify for a lower interest rate, adding up to tens of thousands of dollars in savings over the life of your loan.
Consider these three scenarios, where three consumers who are buying a $400,000 home, with a $320,000 mortgage, qualify for interest rates of 4%, 4.5%, and 5%, respectively. Please note this is just an illustration for educational purposes.
Interest Rate: 4%
Monthly Payment: $1,527
Total of 360 Payments: $549,982.42
Total Interest Paid: $229,982.42
Interest Rate: 4.5%
Monthly Payment: $1,621
Total of 360 Payments: $583,701.48
Total Interest Paid: $263,701.48
Interest Rate: 5%
Monthly Payment: $1,717
Total of 360 Payments: $618,418.51
Total Interest Paid: $298,418.51
That means if your credit score was top notch and you qualified for a 4% interest rate (hypothetically), you’d save $190 a month compared to the 5%, and $94 compared to the 4.5% loan. That sounds nice, but doesn’t seem like big money, right?
But when you compare the long-term savings, the person with the 4% loan saves $68,418 in total payments over the life of the loan compared to the 5% loan, and $33,719 compared to the 4.5%
That’s some HUGE savings for just a very small interest rate difference. So how do you make sure your credit score is ready for the home buying process?
First off, it’s important to understand that the scoring system used by FICO (the Fair Isaac Corporation) is the most popular credit reporting metric, acceppted by almost all mortgage lenders. FICO scores range from 300-850, with a 680 considered good and above 720 an excellent credit score.
So what credit score should you aim for? In fact, 32.8 million people have FICO scores between 700 and 749 but approximately 70 million consumers with FICO scores above 760. But that’s just base camp on the credit score mountain because roughly 36.4 million people have scores between 750 and 799 and 38.6 million are in the 800-to-850 range. Only about 1% of people with FICO scores, around 2 million individuals, ever reach the summit with a score of 800-850.
Your score is calculated based on these factors:
30% Credit utilization (Ratio of debt versus available credit.)
35% Payment history.
10% Mix of credit.
10% New credit.
15% Length of credit history.
So here are some tips to make sure your credit score will be as high as possible when you’re ready to buy a home:
1. Always pay on time.
According to FICO, 96% of people with a FICO score of 785 or greater have no late payments on their credit reports, so be one of those people who have a spotless payment history if you want the perfect FICO. Since payment history is 35% of FICO’s scoring model, paying on time is crucial.
2. Check your credit report periodically.
It's important to make sure that there are no errors on your credit file and everything is in order. These days, you also need to make sure that your identity hasn't been stolen or compromised, which effects up to 1 in 8 Americans every year.
3. Spend less and pay down your balances.
FICO calculates a significant portion of your score by your credit utilization ratio – how much debt you keep to how much your total available balances are. A survey of those who had the top scores revealed their average credit card balances relative to their limits was just 7%.
FICO calculates 30% of their scoring model by the overall money you owe and how close you are to the limits on your credit cards and revolving debt, so low balances and healthy ratios are the key to a top score.
4. Keep a good mix of credit.
Consumers with FICO scores above 760 have, on average, six accounts that are currently “paid as agreed” and an average of 3 accounts with a balance.
5. Keep well-seasoned accounts.
Most super scorers also have, on average, an oldest account that’s 19 years old. The average age of their accounts is between 6 and 12 years old and they opened their most recent account 27 months ago or more. 15% of FICO’s scoring is calculated by the credit history.
6. Start early.
Don’t wait until your ready to start looking at houses or apply for a mortgage to start working on your credit. Get a copy of your credit report for a detailed look both 6 months and then 3 months before you’re ready to apply for a mortgage. That will give you plenty of time to pay down debt, close unwanted accounts, or dispute errors and inaccuracies in order to maximize your score.
7. Do’s and Dont’s during the home buying process.
It’s important not to make big changes during the mortgage process, as it may trigger a red flag for lenders, who are trying to make decisions based on a static snapshot of your finances. Avoid big purchases on credit, moving large sums of money to and from bank accounts, and applying for any new credit or closing existing accounts.
8. Consider getting help.
Whether you sit down with a mortgage professional, bank representative, non-profit counseling center, or a good, trusted credit repair organization, it will help to get advice about improving your credit score from a pro.