Guidance for Improving Credit Scores Before Home Purchase

Understanding the Importance of Credit Scores in Home Buying

Purchasing a home is often the largest investment individuals make in their lifetime. Since credit scores play a critical role in determining the financing terms for a home purchase, it is essential for prospective buyers to understand how to improve their credit scores before applying for a mortgage.

Obtain and Review Your Credit Scores

Begin by obtaining your credit scores from the three major credit bureaus: Experian, Equifax, and Trans Union. Each bureau may report slightly different scores due to variations in the information they collect. Ideally, the scores should be similar—for example, scores like 650, 660, and 640 suggest consistency. However, if there is a significant discrepancy (such as scores of 650, 660, and 570), this might indicate an error in the bureau reporting the lower score. Such errors should be addressed promptly, as they can significantly impact your average score and the terms offered by creditors.

Correcting Errors in Your Credit Report

Identify any incorrect information in your credit file and challenge it immediately. Complete a dispute form, typically located at the back of your credit report, and submit your written challenge via fax or email to the relevant credit bureau. Request confirmation of receipt. Once a bureau receives your challenge, it must notify the retailer involved, who then has 30 days to respond in writing. If the retailer does not respond within this timeframe, the consumer benefits from the doubt. After errors are corrected, your credit score will reflect these changes. Note that this process often takes 30 to 45 days, so it is recommended to check your credit scores 45 to 60 days before closing on a home loan to allow adequate time for corrections.

Avoid New Credit Inquiries

Refrain from making inquiries for additional credit at department stores, automobile dealers, furniture or jewelry stores, or applying for new credit cards. Multiple recent inquiries can reduce your credit score by 3–5 points each. Shopping for lenders is acceptable if similar entries occur within a 30-day period, as they are counted as a single inquiry. This category represents 10% of your credit score.

Manage Outstanding Balances and Credit Utilization

Pay off as many outstanding balances on credit cards and monthly obligations as possible and avoid using your credit cards until after loan closing. This reduces your debt ratio and the percentage of available credit used, both of which positively impact your score. Ideally, keep balances below 30% of your credit limit; exceeding 75% can substantially lower your score. This category accounts for 30% of your credit score.

Make Timely Payments

Ensure all obligations are paid on time. Paying before the due date or using electronic payments helps avoid late payments due to mail delays. A single late payment over 30 days in the past year can be more damaging to your score than a bankruptcy more than five years old, due to the weight placed on recent payment history (35% of your score). If you have a late payment, improve your score by paying on time for the next six months; significant improvement occurs after one year of consistent timely payments.

Avoid Transferring Balances Between Credit Cards

Do not use one credit card to pay off another during the 30–45 days leading up to home closing, as both balances may be reported, increasing your debt ratio and the percentage of available credit used.

Rebuilding Credit with Secured Credit Cards

Those with damaged credit should consider obtaining secured credit cards. Many banks offer these cards, requiring a deposit (e.g., $500) that becomes your credit line. Making timely payments on a secured card can help re-establish your credit and improve your score.

Be Cautious with Consumer Counseling Services

Avoid consumer counseling services when applying for a home mortgage or seeking to maintain a good credit score. Such actions signal credit bureaus that you may have difficulty paying bills and can negatively affect your score, similar to bankruptcy.

Remove Outdated Negative Credit Information

Request the removal of negative credit items older than seven years from your credit report. The only exception should be Chapter 7 bankruptcy, which may remain for more than seven years.

Build a Lengthy Credit History

A long credit history contributes positively to your score, which explains why older individuals often have higher scores. Young people should start building credit early and commit to making timely payments. Credit bureaus now accept alternative credit references, such as letters from landlords, utility companies, and others, to help those with limited credit histories begin building good scores. This category comprises 15% of the credit score.

Checking Your Own Credit Does Not Lower Your Score

Reviewing your own credit report or having a bank perform a credit scan for pre-approval purposes does not negatively affect your credit score.

Using Gifts to Improve Credit and Qualify for Loans

If relatives are willing, they may provide financial gifts to help pay off debts and improve credit scores. Current estate gift laws allow individuals to give $13,000 per year per recipient, and couples can give up to $26,000 per person annually, or $52,000 from one couple to another. Paying off debts with such gifts should occur at least 30–45 days before applying for a loan to ensure the debt payoff is reflected in your credit score. Most loan rejections are due to excessive debt.

Using Gifts to Buy Down Mortgage Rates

Relatives can also provide gifts to buy down mortgage rates, either permanently or temporarily. For example, a $5,000 gift can reduce the interest rate by about 1% for each $100,000 loan over a 30-year term, making qualification easier. Temporary buydowns, such as a 3-2-1 buydown, can lower the initial interest rate significantly.

Relatives as Co-Borrowers

If the buyer’s credit score does not meet the requirements for desirable loan terms, relatives with better credit scores may act as co-borrowers. Many lenders allow non-occupant relatives to join occupant borrowers for high-ratio mortgages. However, the occupant must have decent credit and be paired with someone who has very good credit for this strategy to be effective.

COPYRIGHT JEFF ELIAS 2011      PAGES 254-255     Qualifying Buyers Sect