Credit is the one word we can think of that no one really likes. People with good credit, people with bad credit – everyone gets a little nervous when they think about the magical number determined by a secret algorithm that sums up your entire financial life in one go. The FICO credit score, the defacto standard for scoring your financial well being, is shrouded in myth and mystery and affects just about everything you do in life. And when it comes to real estate, your score is one of the biggest determining factors in whether you’ll be renting or buying your next home. So what can you do to keep your score healthy and happy so that you can move into home ownership? While there is no perfect answer for everyone, there are certain items you should be aware of that will help keep those numbers up so that you can buy a home.
Paying your bills on time. We all slip from time to time and forget to pay a bill by its due date. Whether it’s because you just didn’t have the money until a few days after the due date or it simply slipped your mind, you need to pay your bills on time. Banks look to this factor to see that you have the discipline and structure to keep up with payments. Not only does it affect your credit score, but when a lender looks at your full credit report and sees consistent or frequent late payments, they start to wonder if you’re a credit risk. The website Credit Karma shows that people with fair to excellent credit scores pay their bills on time more than 95%. As credit scores go down, so does the rate of on time payment – FICO scores of 500-599 report 75% on time payment rate, while scores under 500 report 60% on time payment rates.
Debt to income ratios. You debt to income ratio is the balance of what’s coming in and what’s owed. Have large debts and a small income? Not good. How do you figure out your ratio? Take the total of your monthly debts (rent/mortgage, car payments, credit card payments, other loans, etc.) and divide it by your gross (not net) monthly income. Convert the decimal to a percentage (move the decimal two places to the right) and you now know your debt to income ratio. All lenders differ on what they look for, but most avoid anything over 30% and 40% is considered very high. The higher that ratio goes, the higher the risk for you to repay the loan you’re trying to apply for.
Credit Cards vs. Mortgage Debt Although it won’t help the first time home buyer, having a mortgage can actually be a boost to your credit. Things like student loans and mortgages are often weighted differently because of their purpose, whereas credit card debt can be seen as a negative, because we use those to buy things without any real value. That’s not to say that credit cards are bad, you just have to be careful how you use them and how many and how much you have available.
Speaking of credit cards… There are a couple of issues with them that you’ll need to watch out for. First, don’t max them out. Second, don’t have too much or too little credit available. Third, you want to have a strong history with those credit cards, from paying them in a timely fashion and not carrying a large balance to not coming near your spending limits. Credit card debt is one of the trickier items to understand, because each piece of the puzzle affects the larger whole.
Cash. Having a reserve fund can help balance things out when you sit down with a lender. Not only will you need cash for your down payment, but lenders want to see reserve funds so that you can weather any bumps in the road ahead. Cash can sometimes make up for slightly lower credit scores as well.
Your Credit Score is a Complex Thing
These are just some of the issues affecting your your ability to get a loan to purchase a home. The best way to really understand your personal situation is to sit with a local lender and have them take a look. Not only will they pull the report and ask questions about your income and debts, but they will also take a look at the entire picture as a whole in order to come up with the best plan of action for you. Sometimes it makes sense to wait, sometimes you’re ready then and there, but they can help give you the info and knowledge you need, plus they can help you see some of the things you could do to improve your credit score for both the short and long term that could help get you to where you want to be.
If you need recommendations for a quality, local lender who can analyze your situation and build an action plan for you, contact and one of our agents and they can help you find the lender that best suits your needs.
image courtesy of Jigme Datse