How to Build Credit to Buy a House

How to Build Credit to Buy a House

No two credit profiles are identical, and the steps you take to improve yours may vary depending on where you're starting. That said, there are several tips that apply to most people, regardless of their situation.

1. Check Your Credit Report

Start by checking your Experian credit report and FICO^® Score^Θ for free. You can also review your credit reports from the other two credit bureaus—Equifax and TransUnion—at AnnualCreditReport.com.

Your credit score will give you an idea of where you stand, and your reports will help you see which factors are impacting your score—positively and negatively. As you review your credit reports, watch out for areas that need some attention, such as high-balance credit cards, past-due accounts and inaccurate information.

If you happen to find inaccurate information on your credit reports, you have the right to dispute that information with the relevant credit bureau. If the reporting agency confirms your dispute with its investigation, it'll update or remove the negative information accordingly.

2. Make On-Time Payments

Your debt payment history is the most influential factor in your credit score, and late payments can make it difficult to get approved for a mortgage. Even if you do get approved, it could cause an increase in your interest rate.

While you can't do anything about past late payments, make it a priority to pay your bills on time going forward. Here are some steps you can take:

• Consider setting up automatic payments to avoid accidentally missing one.
• Have a cash buffer in your checking account to avoid returned payments.
• If you have any past-due accounts, get caught up as quickly as possible.

Learn more: How to Improve Your Payment History

3. Keep Your Balances Low

Your credit utilization rate measures how much of your available credit you're using on your credit cards, and it's one of the main drivers of your credit score. A high utilization rate signals to lenders that you may be overextended financially, which can lower your score.

Avoid large credit card purchases in the months leading up to your application and throughout the mortgage process. Even a balance you intend to pay off can temporarily hurt your score if it's reported to the credit bureaus before your payment posts.

4. Avoid Opening New Accounts

Every time you open a new credit card or loan, your ability to take on additional debt diminishes. In particular, avoid credit inquiries or new accounts on your credit reports in the six to 12 months leading up to your application.

That's because taking on new debt can impact your credit score. What's more, it can increase your debt-to-income ratio (DTI)—the percentage of your gross monthly income that goes toward debt payments—which can make it challenging to get approved for the loan terms you want.

If you absolutely need to apply for credit, be prepared to explain the reasons to your mortgage lender or consider delaying your mortgage application.

Learn more: Do Multiple Loan Inquiries Affect Your Credit Score?

5. Keep Old Accounts Open

While it's important to pay down credit card balances, avoid the temptation to close old accounts once you've paid them off. Your length of credit history is another factor in your credit score, and getting rid of an old account could potentially lower your score in the short term.

If the card has an annual fee that you no longer want to pay, talk to your credit card issuer about downgrading the account to a card with no annual fee.

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How to Reduce Debt Before Buying a Home

Your DTI isn't included in your credit score, but it's still a major aspect of your creditworthiness when applying for a mortgage.

Most lenders want your DTI below 43%, though some loan programs allow 50% or higher. For housing costs alone, lenders typically prefer a DTI of 28% or less. Here are some steps you can take:

• Pay off small balances first. If you have loans or credit cards with relatively low balances, paying them off can lower your DTI quickly. Note that if you have an installment loan with 10 or fewer payments remaining, you may be able to ask the lender to exclude it from your DTI calculation without paying it off entirely.
• Use the debt snowball method. With the debt snowball method, you make minimum payments on all your debts except the one with the lowest balance, putting any extra money toward that account first. Once it's paid off, you roll that payment to the next lowest balance and repeat until all debts are cleared.
• Consider the debt avalanche. The debt avalanche method targets your highest-interest debt first, which can save you more money overall compared to the snowball approach. It may be the better choice if reducing interest costs is your primary goal.

Tip: Even if you can't pay off your cards entirely, reducing your balances lowers your credit utilization rate. Remember, paying down a card with a high utilization rate can have a meaningful impact on your score.

Learn more: How to Prepare Your Finances to Buy a Home in Five Years

What Other Factors Do Mortgage Lenders Consider?

While your credit history is the most important factor mortgage lenders consider, there are several others that you'll want to pay attention to as you prepare to apply:

• DTI: As previously mentioned, your debt-to-income ratio is the percentage of your gross monthly income that goes toward debt payments. You'll typically want a DTI below 43% to have a good chance of getting approved with favorable terms.
• Employment history: In addition to your income, lenders will want to see a stable employment history. If you've frequently bounced around to different jobs or you've recently switched to a different industry, it could impact your ability to get approved. The same goes if you're self-employed with fluctuating income.
• Down payment: Not all home loan programs require a down payment, but loans with a high loan-to-value ratio tend to be riskier for lenders, which translates to higher rates. If you're applying for a conventional loan, you'll typically have to pay for private mortgage insurance unless you put down 20% or more.
• Assets: Your application will look better if you have sufficient cash reserves and investment assets that you can convert to cash in the event of a financial emergency.

Learn more: What Do Mortgage Lenders Look For?

How to Get a Mortgage

Once you've taken steps to improve your credit and build up a down payment, you're ready to take the next steps in buying a home. Here's what the mortgage process looks like:

1. Gather your financial paperwork. Lenders will ask for documents like pay stubs, tax returns, bank statements and proof of assets, so having these ready ahead of time can speed up the process.
2. Shop around for the best rate. Compare rates and fees from multiple lenders on your own or work with a mortgage broker who can do the legwork for you.
3. Get preapproved. A mortgage preapproval gives you a clearer picture of what you can borrow and shows sellers you're a serious buyer.
4. Shop for a home and make an offer. Once you find the right home, submit an offer and notify your lender as soon as it's accepted so the underwriting process can begin.
5. Lock in your interest rate. A rate lock protects you from rate increases while your loan is being processed, so ask your lender about your options.
6. Attend the closing meeting. Bring the funds for your down payment and closing costs, and be prepared to sign a significant amount of paperwork to finalize the loan.

Frequently Asked Questions

Monitor Your Credit Throughout the Mortgage Process

With most loans, the approval process can occur on the same day, but mortgage loans can take one or two months to close. Before closing, the lender will review your credit history again to ensure that nothing has changed. If your credit score goes down or you've applied for other credit during the process, it could negatively impact your approval odds.

As a result, it's critical that you not only prepare your credit for a mortgage application but also monitor your credit throughout the process. Keep track of your score and watch out for potential issues that arise that could hurt your chances of getting the loan.

With Experian's free credit monitoring service, you'll get access to your FICO^® Score and Experian credit report, along with real-time alerts when changes are made to your report. With this tool, you'll be able to stay on top of your credit leading up to and during the mortgage process.