How to Improve Your Credit Score for Mortgage Approval
Buying a home can be the dream of a lifetime, but what if you don’t qualify for a mortgage due to bad credit? While you can’t fully erase financial missteps from the past, there are things you can do to make amends and boost your score.
Understanding the Importance of Your Credit Score on a Mortgage Approval
When applying for a mortgage, you may be wondering why a bank is interested in your credit, particularly when you already have a steady income, solid employment, and money for a down payment. The answer makes more sense if you consider the factors that go into calculating your credit score.
First, your credit score is based on your credit history, which includes things like payments you’ve made or continue to make on current debts and the amount of debt you owe. Your credit history also reveals information important for loan qualification, such as how you use credit, how often, and whether you are overextended.
One of the primary ways lenders use this information is to help determine your debt-to-income ratio (DTI). DTI is a financial ratio that divides your monthly debt payments by your monthly gross income.
In most cases, you’ll need a DTI around or below 45% to qualify for a mortgage. That means your monthly debt from credit cards and loans must comprise less than half of your gross pay. A borrower above this limit may find it more challenging to secure a mortgage or will pay a higher interest rate.
What to Do if Your Credit Doesn’t Meet the Mark?
Even if your credit history is a bit tarnished, it doesn’t necessarily mean you can’t purchase a home but you may have to roll up your sleeves and take a few crucial steps to improve your credit score.
- Change Your Habits
If late or missed payments plague your credit history, be sure you make your payments on time in the future. Likewise, if you’re overextended with too much debt, make it a priority to pay down outstanding balances and don’t take on new debt, even if that means putting your credit card(s) on the shelf for awhile.
- Don’t Close Your Old Credit Card Accounts
It’s tempting to close out accounts, particularly if you don’t use them, but eliminating a card can reduce your “utilization rate” because it will appear as if you are using a greater percentage of your available credit.
Think of utilization rate this way: say you have three credit cards and each card has a $1,000 limit. That means you have a total of $3,000 of credit at your disposal. If you currently owe $1,500 across the three cards, you are utilizing 50% of your available credit. That’s your utilization rate.
However, if you close one of the cards, your available credit drops to $2,000. That same $1,500 in credit card debt is now consuming 75% of your available credit, increasing your utilization rate. Lenders factor in this ratio when underwriting a home loan so it’s important to consider.
- Don’t Apply for New Credit
Each time you apply for credit, it results in a hard inquiry on your credit report, which can lower your credit score. If you’re approved, you will also increase your available credit, something that could hinder your chances of being approved for a mortgage.
In general, it’s a good idea to avoid taking on new debt or taking out new lines of credit while trying to qualify for a mortgage.
- Mind the Payments You Make with Credit
Often, individuals will use credit cards at grocery stores or to pay reoccurring bills, such internet and cell phone. This practice could pose problems if you’re applying for a mortgage and your credit score isn’t meeting the mark.
Remember that debt-to-income ratio we discussed? When assessing this metric, your lender won’t include monthly payments for things like food, internet, or phone. However, your monthly credit card payment will be included in that calculation. Once you use your card for expenses such as these, the amount charged goes toward determining your minimum monthly payment, and it could be just enough to push your DTI over its limit.
- Make, and Keep, a Recovery Plan
How quickly you’ll be able to improve your credit score depends on two things: how serious you are about changing habits and that you take the steps that will have the greatest impact. A credit advisor can help you determine the best actions to improve your score and even help you resolve past issues, particularly if you have judgements or collections against you. An experienced loan officer can also help guide you down the right path.
As you settle more serious hits to your credit, be certain to follow up with the agency for proof that you’ve cleared the debt. It can take months for actions to be recorded and you’ll want to make sure you are monitoring since you’re the one with the most at stake. If you have a proof in hand that you have resolved an outstanding collection or judgement, you can show it to your lender, while the recording catches up.
Congratulations, Your Credit Can Meet the Mark
Maybe the road won’t be perfectly smooth, but it can be less bumpy if you’re following the recommendations of your credit advisors and lenders. A good credit score is more than a means to purchase a home, it’s an investment in your financial future giving you the freedom to take out a line of credit, or a loan, without question and exorbitant rates. Homeownership is attainable, and you’ve just taken the first steps to taking control of your credit!
The articles in this blog are for informational purposes only and not intended to provide specific advice or recommendations. When making decisions about your financial situation, consult a financial professional for advice. Articles are not regularly updated, and information may become outdated.