Keep your credit healthy when seeking a mortgage
Tips for keeping your credit score prime
- Pay your bills on time, don't exceed your credit-card limits and avoid frequent credit inquires.
- Before seeking a home loan, check your credit report and pay down credit cards.
- After applying for a loan, avoid significant expenditures and don't apply for new credit.
When trying to secure a loan that is often worth hundreds of thousands of dollars, it's amazing how much boils down to the three small numbers in your credit score.
A credit score, which is derived from information in a credit report, is a key factor used by a lender to determine whether a potential homebuyer will qualify for a mortgage and at what interest rate. Lenders can use a variety of credit-score tools, but the most used is the FICO score, which ranges from 300-850, with a higher score indicating better credit.
There are things people can do to keep their credit score high at all times, such as paying all bills on time, staying well below the limits on their credit cards and avoiding several credit inquiries in a short period of time. There also are steps to follow when preparing to apply for a mortgage and while the loan is being underwritten or during the closing process.
Before applying for a loan
Perhaps the most important credit step someone can take before applying for a loan is checking their credit score and report to make sure everything is accurate. There are three main, nationwide credit-reporting agencies, and Americans can obtain one free report from each agency per year.
If anything is inaccurate in the report, you have the right to challenge it with the reporting credit agency. If possible, include any proof that the information is wrong — although, according to Elizabeth Karwowski, CEO of Get Credit Healthy, you should dispute this information only once in any 30-day period to avoid triggering extra investigations.
Karwowski also recommends paying down any credit card debt to the point where you are using 30 percent or less of the available credit on each card. If, however, you have any past collections that are due, it's best to not immediately pay them off, as the activity date on those collections would then become more recent, which could negatively impact your score. Instead, you can try to negotiate with collectors to remove the collection from your report in exchange for payment.
Assuming everything is accurate in your credit report, it's best to avoid any big purchases shortly before starting the loan process. Any purchase that could result in new debt could negatively impact your credit.
After applying for a loan
Compare mortgage lenders to see what loans and rates are available to you given your credit score. Even after you have applied for a mortgage, your credit work continues. Any changes made to your credit during the application, underwriting and closing processes could result in a change in interest rates, a delay in obtaining your loan, or even a denial of the loan.
There are obvious ways to keep credit up during this time, such as avoiding late payments, which could have a severe, negative impact on your credit score. But there are also other items that could hinder your ability to get the loan of your dreams.
Any significant purchase should be avoided for two reasons. First, it would likely increase the balance on your credit cards, which can damage your score. Second, some large purchases also require a credit check — and additional credit checks are a bad thing when you're in the midst of the mortgage-lending process.
"Applying for new credit can be a red flag to lenders, but it also creates an inquiry on your credit report," Karwowski says. "Inquiries are 10 percent of your credit score. Those few points can negatively affect a homebuyer [preventing the individual] from getting the loan they want or even qualifying for a loan."