Through April 20, 2021, Experian, TransUnion and Equifax will offer all U.S. consumers free weekly credit reports through AnnualCreditReport.com to help you protect your financial health during the sudden and unprecedented hardship caused by COVID-19.
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If you plan to buy a home in the coming year, taking steps now to spruce up your credit profile can increase your chances of qualifying for a mortgage and reduce the amount of interest you'll be charged on the loan.
When lenders are deciding if you're the kind of borrower they want to do business with, they typically begin with a review of your credit history. When you submit a mortgage application, they'll check your credit reports maintained by one or more of the three national credit bureaus (Experian, TransUnion and Equifax), and the credit scores derived from those reports. Lenders use credit information to help decide whether they're willing to issue you a home loan and, if so, how much they're willing to lend you and how much they'll charge you in interest.
In light of that, and because a mortgage could be the largest financial decision a person ever makes, it's prudent to prepare for a mortgage application by reviewing your credit yourself, and taking steps to present it in the most favorable light.
Check Your Credit Reports and Scores
The first step in prepping your credit for a mortgage is learning where your credit currently stands. That means checking your scores, and getting your credit reports from all three credit bureaus (Experian, TransUnion and Equifax) to review the factors affecting them. You can get a free credit report from Experian, Equifax and TransUnion at AnnualCreditReport.com.
Review each credit report carefully to make sure it accurately reflects your credit history. If you get all three reports at the same time, don't be surprised if there are minor differences between them. Your lenders may not report all of your accounts to every credit bureau, or may send updates to the credit bureaus on slightly different schedules. So there's no need to be alarmed if, for instance, your Experian report reflects the most recent payment on your credit card but your TransUnion report doesn't show it yet.
Here are some things to look for when you get your reports:
- High account balances relative to your credit limits. Paying down your balances will help your credit scores.
- Past-due accounts, charge-offs and accounts in collections. If possible, bring all accounts current and pay off any outstanding collection accounts.
- Loans or credit accounts that shouldn't be there (which could indicate criminal activity), and payments incorrectly listed as late or missed. If any inaccuracy exists, follow the dispute process for the relevant credit bureau as soon as you can.
At the same time you're checking your credit reports, it's a good idea to take a look at your FICO® Score☉ (which you can get for free from Experian and other companies). A credit score distills the contents of your credit report into a three-digit number, so if there are improvements made in your reports, your score will likely increase once that information is reported to the credit bureaus. Credit scores play an important role in determining whether you qualify for a mortgage—lenders may decline applications from individuals whose credit scores are too low. Lenders also use credit scores to help set the interest rates they charge, with higher credit scores typically translating into lower interest rates.
For example, say you start out with a FICO® Score of 675. According to the FICO® Loan Savings Calculator, you could purchase a $300,000 home with a 20% down payment (total loan amount of $240,000) and qualify for a 30-year fixed mortgage with an interest rate of about 3.04% at national rates as of mid-November 2020. Boosting your score just a few points, to 680 or more, could qualify you for an interest rate of 2.83%—saving you nearly $10,000 ($9,924) over the life of the loan. Bringing your score up to 700 could land you a rate of about 2.65%, saving you an extra $18,000. And if you could get your score to 760, an interest rate of about 2.43% could help you save $28,000 over what you'd currently be paying.
For an even more complete picture of your credit scores and how to improve them, consider Experian's 3-Bureau Credit Report and FICO® Scores product. In addition to the ability to view your Experian credit report and the FICO® Score based on it, you'll see scores and explanations based on your credit reports maintained by the other two credit bureaus.
When you receive your scores from Experian, you'll also get some explanatory notes on what's affecting them (called risk factors) and how you can make improvements. Those suggestions can help you find focus when making moves to improve your scores in the months ahead. It's also wise to be mindful of the main factors that affect all credit scores, and to adopt habits that tend to promote score improvement.
When preparing to apply for a mortgage, the following steps are generally advisable to all borrowers.
Stop Applying for New Credit and Limit Big Purchases
Anytime you seek new credit or take on new debt, the statistical risk that you'll fail to repay your debts—as it's perceived by lenders and credit scoring models—tends to climb. For that reason, a credit check associated with a credit or loan application could cause your credit scores to drop slightly, although they may not drop at all. Scores also tend to dip when you accept a new loan or credit offer. These reductions are commonly just a few points each, and your scores typically recover within a few months as long as you keep responsibly managing your credit, but even slight drops should be avoided when you're preparing for a mortgage.
Beyond credit scores, mortgage lenders consider your total debt load in relation to your income, called your debt-to-income ratio, when deciding how much they're willing to lend you. For that reason, it makes sense to avoid making any major purchases with your credit cards leading up to a mortgage application.
Even if you can pay cash, it's wise to avoid large non-emergency purchases in the year or so preceding a mortgage application, since lenders will also consider your savings—and because putting cash reserves toward the down payment on your home instead of spending it now could save you thousands of dollars over the life of your mortgage.
Reduce Credit Card Debt
If avoiding new debt helps burnish your credit, it's probably no surprise to learn that lowering existing debt can also help your credit standing. Paying down credit card balances is a great way to address this. Paying them off altogether is an ideal goal, but that isn't always feasible within the span of a year or less. In that case, it's wise to be strategic about which balances to tackle when paying off your credit cards.
One of the biggest influences on your credit scores is credit utilization ratio—the percentage of your credit card borrowing limits represented by your outstanding balances. Understanding how credit utilization affects your credit scores can help you determine the smartest approach to paying down your current balances.
Your overall credit utilization ratio is calculated by adding all your credit card balances and dividing the sum by your total credit limit. For example, if you have a $2,000 balance on Credit Card A, which has a $5,000 borrowing limit, and balances of $1,000 each on cards B and C, with respective borrowing limits of of $7,500 and $10,000, your total your utilization ratio is:
You also can calculate the utilization ratios on each individual card:
Most credit scoring models start to ding your scores once utilization ratios near or exceed 30%. Total utilization is the most important factor—and paying down any portion of a card's balance reduces that—but the guideline also applies to utilization ratios on individual cards.
In our example, the total utilization ratio of 18% is well under 30%, but the ratio for Card A is significantly over that amount, at 40%. So when determining how best to pay down debt to promote credit score improvement, it'd make sense in this case to focus first on reducing Card A's balance.
The 30% figure is more of a general recommendation than a hard target. If you reduce your total utilization ratio from 32% to 29% you shouldn't expect a major surge in scores. Nevertheless, higher utilization typically leads to lower credit scores, and vice versa.
Focus on Paying Every Bill on Time
Another factor that plays a major role in your credit scores is payment history. Late payments—especially recent late ones—can significantly drag down your credit scores. So in the months leading up to mortgage application, make sure to pay every bill on time.
If timely bill payments are a challenge for you, consider using technology to help: Automated electronic payments from your checking account can help you avoid accidental late payments. Calendar alarms, text-message email reminders can help as well.
Do whatever it takes, because lenders will likely see a late debt payment within the 12 months leading up to a mortgage application as a significant red flag. It might not prevent you from getting a mortgage, but it could mean you'll be seen as a relatively risky borrower, and that could mean higher interest costs.
Additional Ways to Improve the Odds of Mortgage Success
Credit is a major factor in determining your ability to get and afford a mortgage, but it's not the only influence. Some other approaches you can take to boost your chances of mortgage success include:
- Save for a larger down payment. Lenders love borrowers who demonstrate good savings discipline, and the more cash you have to put down on your new home, the less you'll have to borrow—and the less you'll spend over the course of repaying your mortgage.
- Resist seeking more house than you need—or can afford. There's more to being able to afford a house than simply covering the monthly mortgage payments. You'll need some money in reserve each month to cover house-related maintenance and repair costs, in addition to everyday family-related expenses that often accompany homeownership. Take care to be realistic about what your savings and income will support, and shop for a home accordingly.
- Consider using a mortgage broker. If you're not getting mortgage offers you like through the traditional loan application process, working with a mortgage broker who's familiar with multiple lenders and their target borrowers could help match you to a lender and a loan that suits your needs.
Taking steps today to prepare for mortgage applications in the coming year can make a significant difference in the number of mortgage offers you receive, and the total amount you'll pay on your mortgage loan. Putting your best credit profile forward can mean big savings as you begin the process of buying a new home.