So you’re getting ready for your first home purchase. This is the first in a two-part series. The second is entitled, How Much Mortgage Can I Afford? To qualify for a mortgage you need a good credit score.
Down payment and qualifying for a mortgage
In buying your first place you’ve got two main considerations: Coming up with a down payment is number one. Number two is being able to qualify for a mortgage loan. In this post, I hope to help you get ready to obtain your first mortgage. Specifically, you’ll learn how to get a good credit score in order to qualify for a mortgage.
Good credit is accurate credit
Your first project is to make sure that your credit report is accurate. I say project, because it may very well be just that – a project. There are three major credit bureaus: Experian, Transunion, and Equifax. Each time you make a reportable event with one of your credit grantors – say Macy’s – that event shows up on your credit report. So you want to be sure that that report is 100% accurate. Don’t spend any money on this: simply go to annualcreditreport.com, and you can obtain each one of your three credit reports there once a year free of charge. The strategy, then, on an ongoing basis is to pull one of the credit reports every four months. Check all three for accuracy.
Challenge credit report errors
On your credit report you will see, by credit grantor, the credit limit, the high balance, the current balance, and your payment history. If you see something that is not accurate you can challenge it. The way information gets on the report in the first place is that the credit granting entity has reported it to the bureaus. Mistakes happen.
If you see something there that is an inaccurate you have every right to challenge it. You notify the credit bureau in writing, usually online, and they will take your challenge back to the credit grantor. The credit grantor will then either correct the information or, if it cannot be substantiated, the bureau will remove it from your credit report. This project – getting your credit report squared away – is your first step in qualifying for a mortgage loan.
Avoid credit repair scams
Note: I believe most credit repair services that offer to “fix” your credit for a fee are a consumer rip-off. They don’t do anything that you can’t accomplish on your own, at no charge to you, as I’ve described above. Follow the steps in this post to build up good credit and that will usually be enough.
A good credit score
Next you want to look at your credit score. The range of credit scores is from 350 to 850. Credit score and FICO score is often used interchangeably. FICO is simply an acronym for the Fair Isaac Company. Fair Isaac calculates the score that 90% of credit grantors use. 700 is considered a good credit score. Of course, with a higher score you’ll pay a correspondingly lower interest rate on your loan. What happens if your credit score isn’t so terrific? It doesn’t necessarily mean that you’re locked out of the mortgage market – just that you may not qualify for the most favorable interest rates.
How is your credit score determined?
Over time you can affect your credit score greatly. You’ll want to know how your credit score is calculated and what credit grantors think are most important. In other words, how is a good credit score determined? Here it is:
35% of your credit score calculation is based on your payment history
Whatever you do – even if it’s just the minimum payment – get it in on time every month.
30% of your score is reflected in the amounts you owe
Keep the amounts you owe as small as you can relative to the credit line. Try not to use more than half of the available credit. Lower is better.
15% of your score is the length of your credit history
Keep accounts open and active! If you don’t have much history, you can gain some by charging a purchase each month, waiting till the bill comes, and then paying it off. One way to keep an account open and active is to buy an occasional tank of gas with the card. Just remember to pay the balance when it comes due!
10% of your score is your credit mix
You want a balance of credit cards, department store cards, installment loans (such as auto loans), and mortgage loans.
10% of your score comes from new credit
Don’t open up a lot of accounts in a short period of time. This makes you look sketchy to a lender.
How to get a good credit score
Your credit score is calculated only on what is in your credit report. If you have a private loan, say to a family member, that won’t do anything for you in terms of raising up your score. If you need to see your score rise, take these actions:
Once you’ve got yourself a good credit score, you are ready to shop yourself out to mortgage lenders. Notice I didn’t say shop around: You are now creditworthy and with a down payment. They need YOU! You are in a strong position, so go see what the market has to offer you.
In the next post I’ll talk about what banks look for when they lend mortgage money.
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Have a great day!
Jonathan G. Cameron, CFP®
Registered Investment Adviser in Miami, FL