When it comes to shopping around for a mortgage to buy a home, a critical factor to check is your credit score.
Lenders use your credit score (also called a FICO score) to decide whether to lend you money to buy a home and at what interest rate.
“Lenders give credit based on their trust in you to pay back what you borrow,” says Stephen Rosen, sales manager at mortgage company Better. “If you are worthy of the financial confidence of a lender, you are said to be solvent or have ‘good credit’. Building credit is almost like building a reputation with lenders.
Credit scores range from 300 to 850. Although the definition of good/bad credit varies slightly from creditor to creditor, here is a general overview:
Excellent credit score: 750–850
Good credit score: 700–749
Fair credit score: 650–699
Bad credit rating: 649 and below
Unfortunately, it’s easy to make mistakes that lower your credit score and jeopardize your chances of getting a home loan. Here are the five worst credit mistakes a homebuyer can make, plus how to turn the tide and get your credit back on track.
History of late or missing payments
Whether or not you have paid your bills is a major concern for lenders. Thus, your payment history represents 35% of your credit score. Late payments, missed payments, and defaults such as tax liens weigh heavily on credit.
Worse, if you haven’t made a payment on your credit card debt for a while (six months or more), your creditor may “debit” your account as uncollectible and sell it to a collection agency.
The obvious solution here is to pay off your debts on time or by remembering your monthly payment.
If automatic payment isn’t your thing, set calendar reminders for each bill’s due date to make sure everything gets paid on time, Rosen suggests.
High credit balances
Your debt represents 30% of your credit score. As such, having a high credit card balance can also lower your score.
Ideally, you want your credit utilization — the amount of debt you have relative to your credit limit — to be low, around 30% to 40% of your credit limit. So if you have a credit limit of $5,000, using $2,000 a month rather than maxing out the entire $5,000 will help you build a better credit score.
Set up credit card alerts so you know how much of your credit limit is used.
Short or patchy credit history
The length of your credit history is 15% of your score. And the longer your accounts stay open, the better. This includes your credit cards, student loans, auto loans, or rental history.
Lenders will want the customer to have more than 24 months of credit history.
If you have old credit cards that are still good but you’re not using them, don’t close those accounts. Closing paid credit cards can actually hurt your credit score because it reduces the overall length of your credit history.
Limited credit mix
The credit mix is the variety of loans on your credit report, such as credit cards, student loans, and auto loans. Having a combination of credits is a good thing because it demonstrates that you can juggle paying off several different debts at once. A credit mix contributes 10% to your credit score.
However, don’t open up additional credit cards or take out new loans in an effort to get a good mix of credits if you can’t pay them.
Too much new credit
The new credit represents 10% of your score. What lenders don’t want to see is that you’ve opened many low-limit credit card accounts or applied for new credit in a short period of time.
They interpret this as a signal that you are having trouble managing credit. Additionally, opening new lines of credit decreases the average length of your credit history, which can also hurt your score.
You might have too much credit if you’re struggling to make your monthly payments and have a lot of debt, especially new debt. So avoid opening new lines of credit unless necessary and when you know you can pay your bill each month.
If you’ve made a credit mistake like any of the ones listed above, it’s not the end of the world. However, it will take time, so be patient.
Some of the items that stay on your credit report for years include the following:
Bankruptcy: 7 to 10 years
Foreclosure/mortgage default: seven years
Tax liens (unpaid property tax): up to 10 years for unpaid liens
Accounts struck off: seven years
Prosecutions and judgments: seven years (even if a judgment has been satisfied)
However, imperfections in your past credit score won’t necessarily prevent you from getting a mortgage. Talk to your lender and be prepared to explain what happened in the past and what steps you took to correct the problem.
This report was provided by Realtor.com.