A Short Guide To Credit Health

We are increasingly dependent on credit; therefore, it is necessary that you have a good understanding of personal credit reports and your credit score before beginning the process of buying a home.  When you apply for credit, your credit score is checked.  A credit score in the 500s is poor, while one in the 800s is excellent.

Depending on your credit score, lenders will determine what risk you pose.  Increased credit risk as shown by a low credit score means that a risk factor is added to the price at which money is lent.  If you have a poorer credit score, lenders will lend you money at a higher interest rate than one paid by someone with a better credit score.  Below a certain score, lenders will not even deal with you.

Here is a short guide to help ensure that your credit is in good shape before you jump into the mortgage market.

Monitor and analyze your credit history.

With your credit score being such a crucial aspect of the final approval on a mortgage, it is important to have a current idea of how your score is going to affect you.  Keep a tab on your score well in advance.  This will help you to have an accurate estimate of the rate that you can expect.  If your credit score is good, it will help you get approval.  Take this opportunity to find out areas where your credit history could use improvement and take steps to make sure those improvements happen.

Report errors and inconsistencies.

A study by the Federal Trade Commission (FTC) stated that one out of every four consumers had errors in their credit reports that were significantly affecting their scores.  It also revealed that 5% of consumers found errors that, if left unresolved, would have led them to pay significantly higher amounts for mortgages and loans.  Do not let errors on your report make you pay more than you should.  Make sure you pull and carefully check the three credit bureau reports and be sure to dispute any errors that would affect your score such as wrong credit limits or incorrect accounts.

Decrease the percentage of your income that goes into paying debts (your debt-to-income ratio).

According to Bank of America, keeping your debt at a manageable level is a requirement of good financial health.  Your debt-to-income ratio compares your monthly debt expenses to your monthly gross income.  To calculate your ratio, add up the payments you make toward debt during a month.  That includes your monthly credit card payments, car loans, other debts (such as payday loans or investment loans) and housing expenses, either rent or costs for your mortgage principal, plus interest, property taxes and insurance (PITI: Principal, Interest, Tax and Insurance) and any homeowner association fees.  Next, divide your monthly debt payments by your monthly gross income, your income before taxes are deducted, to get your ratio.  Your ratio is often multiplied by 100 to show it as a percentage.  For example, if you pay $400 on credit cards, $200 on car loans, and $1,400 in rent, your total monthly debt commitment is $2,000.  If you make $60,000 a year which is $5,000 gross per month.  Your debt-to-income ratio is $2,000 / $5,000 which is 0.4 or 40% While the preferred maximum varies from lender to lender, it is often around 36%.

Beware of applying for credit.

You want your credit score as high as possible when applying for a mortgage.  Thus, you should try to avoid getting more credit, especially when your underwriter is deciding on your mortgage.  Every credit application you fill out during this time could lead to an inquiry that might significantly decrease your score.

Keep your credit clean before purchasing a home.

When it comes to your credit and purchasing a home, you must be extremely careful how you handle your money.  One wrong move and you can wave goodbye to your new home.  In the case of purchasing a new home through an application for a mortgage, it is best to wait before taking out any credit cards or applying for a car loan.  If it is impossible to wait, make sure you speak to your loan officer or mortgage broker for some advice.  You do not want to risk losing your home.