Each year, hundreds of thousands of individuals make the dream of owning a home a reality. Despite some less-than-optimistic predictions for the housing market over the next few years, prospective homeowners are finding a place to call their own while interest rates remain relatively low and inventory of homes is tightening.
While buying a home can be beneficial to building wealth over the long term, the process is not simple. Purchasing a home requires a strong financial track record, a high credit score, and the ability to regularly repay a mortgage loan.
How Credit Affects Buying a Home
For homeowners gearing up to buy a home, credit is a common problem. Lenders need to feel comfortable with your ability to manage a substantial amount of debt.
“Lenders are looking at credit scores which are a predictive measure of how likely you are to repay debt, based on your past repayment habits,” Brian Willingham, loan officer with Citizens Bank, says.
>> Read More: What Credit Score is Needed to Buy a House?
Credit scores are calculated by factoring in payment history, length of credit, recency of new accounts, inquiries, and current accounts in use. Credit history plays a role in lenders’ mortgage decisions as they evaluate derogatory events like bankruptcies, judgments, foreclosures, short sales, or other significant payment delinquencies.
In cases where credit history and credit score negatively impact a mortgage application, potential borrowers may be denied altogether, or they may be offered a less than ideal loan. This means that because the lender sees the borrower as a risk, the interest rate will likely be much higher than someone who has a strong financial history and high credit score.
A higher interest rate on a long-term debt like a mortgage can be incredibly costly over several years of repayment, making it crucial to know the steps to take to boost credit.
Repairing Credit to Buy a Home
Having bad credit won’t prohibit you from owning a home, but you need to create a plan for improving it, especially if you plan to purchase a home in the near future.
To ensure you are in the best position to qualify for an affordable mortgage loan, follow these steps:
1) Check Your Credit Reports/Scores
The first step in improving credit before buying a home is to know where you stand. Your credit report provides details of your financial life, past and present, so this is the best place to begin fixing your bad credit.
Every consumer can pull their credit reports from the three main credit reporting agencies – Equifax, Experian, and TransUnion – once per year, at no cost. You can request your credit report through a simple online form or via a written request to each of the credit bureaus.
If you have already pulled your credit report within the year, you can use one of the best free credit report sites at no cost.
Once your receive your report(s), review the information on the reports for accuracy, as well as any negative entries that may be dragging down your credit score. Having this information is crucial if you want to improve your credit score and history before purchasing a home.
2) Clean It Up
If there are errors on your credit report, such as a debt entered that is not yours or a collections account that you are not responsible for, you should dispute that inaccurate information.
The dispute process is part of your rights as a consumer, and it begins with identifying incorrect information on your credit report. You can follow the dispute process with each of the credit bureaus to have the negative entry removed. This can be done online or in writing.
Be sure to include supporting documentation if possible, and follow up after 30 days to see if the error has been resolved or removed. Simply removing errors from your credit report can result in an increase to your credit score in a short period of time.
If you have negative items that are not errors, know that time heals most credit wounds. Credit score calculations are more focused on the last 24 months when it comes to negative entries, so if you’re close to that timeframe, be patient.
Additionally, other negative entries, such as collection accounts, late payments, or bankruptcies, may stay on your credit report for seven years. However, if this timeframe has already passed, dispute the information through the process mentioned above.
3) Get Current and Stay Current
In addition to removing errors, you can work on cleaning up your credit before buying a home by getting – and staying – current on your debts. Bring any past due accounts into paid status, and focus on implementing smart, responsible payment habits moving forward.
For some, this is most easily done by setting up automatic payments. Automating the process makes it easier to keep up with regular payments for loans, credit cards, or other debts. It also improves your payment history each month as you stick with the plan and prove you can reliably pay your bills.
4) Pay Down Credit Card Balances
Credit utilization also plays a part in the credit score calculation. “High balances on credit cards also negatively impact scores, although not as much as late payments or collection accounts,” Willingham says. Having available credit is necessary for showing creditors and lenders that you can be responsible with the money provided to you over time. According to Experian, credit utilization should be kept at no more than 30 percent if you want to best possible credit score calculation in this area.
5) Adding Positive Credit History
Adding positive credit history is another part of the process toward boosting your credit score before purchasing a home. Positive credit history boils down to on-time payments, low credit utilization for an extended period, and responsible use of available credit accounts.
If your credit is not strong enough on its own to get a new credit card or loan that will help build positive credit history, consider being added as an authorized user or joint owner for an already-established account. So long as payments are made when they are due and you do not overextend your spending, building positive credit history is a simple.
6) Planning Ahead
If your credit is not as strong as it could be and you want to purchase a home soon, be sure to create realistic expectations. Improving your credit score and history takes time, just like getting bad credit is not an overnight process. Plan ahead for several months of smart financial activities. Boosting your credit is a slow, steady journey, and if you’re patient, you can achieve your goal of purchasing a home in the near future.
If you are struggling with how to fix bad credit before buying a home, the steps listed above should be your first course of action. Start with a review of your credit and identify what can be disputed or correctly quickly.
Follow up with consistent payments on current debt, establishing new, positive credit, and remember that it takes time for your credit to reflect these positive changes. Taking these simple steps can make your home buying dream a reality without the unnecessary cost of a higher interest rate.