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You've been saving up to buy a home, and you're ready to start looking for your dream place. But is your credit in the best shape it can be to help you qualify for a mortgage—and at the best rates available?
Before you start shopping for a new house, you'll want to make sure your credit is in tip-top shape. In fact, you should start focusing on your credit at least six months to a year before applying for a mortgage. Because this is likely the largest loan you'll undertake in your life, even small improvements in your credit score can translate into significant savings.
For example, say you start out with a FICO® Score* of 675. According to the FICO Loan Savings Calculator, on a $300,000, 30-year fixed mortgage, you would qualify for a interest rate of 4.74% in the current interest rate environment. But if you boosted your score by just five points into the next scoring band, you could qualify for an interest rate of 4.53%—saving you $13,840 over the life of the loan. If you improved your score to 700, you could qualify for a rate of 4.35%, saving you an extra $25,158. And if you could get your score to 760, your 4.13% interest rate would help you save $39,186.
Follow these four steps to get your credit in fighting shape before you apply for a mortgage:
1. Check Your Credit Reports and Scores
The first thing you should do, if you haven't already, is find out where your credit currently stands. That means obtaining your credit reports from all three credit bureaus (Experian, TransUnion and Equifax) and reviewing them for errors.
Make sure each credit report accurately reflects your identity and credit history. Are there any accounts listed that shouldn't be there? What about late payments that may not be correct? If errors do exist, get those corrected as soon as possible because they could be dragging your scores down.
You can get your free credit report from Experian—no credit card required. You are also entitled to one free credit report every 12 months from Experian, Equifax and TransUnion at AnnualCreditReport.com.
Also take a look at your FICO® Score (which you can get for free from Experian) to find out where you're at. When you receive your score, you will also get some information about why your score is what it is and how you can improve it. Pay close attention to those suggestions, because that's what you'll want to focus on to improve your score over the coming months.
For the most thorough breakdown of your three credit reports and FICO® Scores based on each, consider Experian's 3-Bureau Credit Report and FICO® Scores product. You'll get insight into each of your credit reports and scores, as well as access to live customer support.
Find more information on the factors that go into your credit score here.
2. Stop Applying for New Credit and Limit Big Purchases
Don't apply for new credit cards or undertake other loans—such as a car or personal loan—in the months before you apply for a mortgage. New loan and credit applications can ding your scores in the short term, so you'll want to avoid any new activity that could harm your scores.
Similarly, limit large purchases, especially if you're using credit to pay for them.
Now is the time to decrease your credit usage to signal to potential mortgage lenders that you're not over-leveraged. (And even if you plan on making a big purchase with cash, consider skipping it to burnish your savings—because that will also impact your ability to secure a loan and pay for all the costs related to buying a home.)
3. Reduce How Much You Owe and Pay Down Your Debt
One of the biggest factors that impacts your credit scores is your credit utilization ratio, or the amount of credit you use each month compared with the amount of credit that's available to you.
Your credit utilization ratio is calculated by adding all your credit card balances at any given time and dividing that by your total credit limit. For example, if you owe a total of $2,000 on all your credit cards, and your total credit limit across all your cards is $10,000, your utilization ratio is 20%.
Experts say that most credit scoring models ding your score if your utilization ratio is above 30%. So it's smart to aim for a utilization ratio under that—but don't expect your score to magically jump up if your utilization is at, say, 29%.
Think of it as more of a sliding scale. The higher your utilization ratio, the bigger hit your credit scores will take. To be on the safe side and achieve the best scores, you'll need a credit utilization ratio of 10% or less. Find more details on how much credit you should use here.
The best way to decrease your credit utilization ratio is to pay down your debt as much as possible and limit the spending you put on credit cards each month.
4. Focus On Paying Every Bill on Time
The other factor that plays an outsize role in your credit scores is your payment history. Late payments—especially recent late payments—will significantly drag your scores down. So focus on paying your bills on time. In fact, consider automating your payments so you don't miss a bill accidentally. You might also set up text and email payment alerts to remind you when bills are due.