The Seacoast BankNote

Follow These Steps to Great Credit Before Purchasing a House

Posted by Seacoast Bank on Mar 15, 2019 11:29:28 AM

 

AdobeStock_180490821Great credit is essential to optimizing the house buying process. The majority of us will not be able to access real estate without having our credit in order. If you are going to take the time to do this, take the time to do it well. The investment that you make in real estate will be yours for years to come. Following the steps to great credit does not involve years of commitment. Even small improvements in your credit are more than worth the time.

Although there are differences of opinion concerning certain steps in the credit process, you can always count on the same basic procedures. This article will take you through a detailed assessment of the steps that everyone has to take in order to ensure optimized credit before a house buy.

Get Your Credit Report

Even if you have already used up your three free credit reports for the year, get a recent copy of your credit before you go into mortgage lenders looking for a home loan. In general, your latest credit report should be no older than three months in advance of your bank visits. If you know that you have delinquent items on your credit report, then you will need at least six months to optimize your credit.

Even if you know that your credit is perfect from your end, you want to obtain a recent copy of your report for one major reason – the credit rating agencies may screw up your credit accidentally. What's more, they have zero incentive to fix their mistakes. The only one who will suffer from Experian's mistake on your credit report is you. Fully 25 percent of people every year who are declined for a mortgage loan came to the banking institution with inaccuracies in a credit report.

Take the time to dispute all inaccuracies on your credit report. You may even want to dispute items on your credit that you know are your fault. You may get them cleared up simply because the creditor does not have time to dispute the issue with you. Yes, you may be filing multiple credit dispute reports, but they are well worth the time.

Important: The better your credit score, the lower your interest rate. One-half of a point over the life of a 30 year loan can translate into a savings of hundreds of thousands of dollars.

Checking Your Tradelines

A very important financial terms that goes overlooked is the "tradeline." A tradeline simply means that you have an open line of credit that is active within the past 1 to 2 years.

If you are looking for a loan from the Federal Housing Authority (FHA), you will need at least two open tradelines. Conventional loans require you to have one more tradeline for a total of three. Why do financial institutions like to see that you have other credit lines open? Real estate is such a large investment that banks cannot be sure you will make good on your credit unless you have proof of doing just that.

The Numbers on Your Tradelines

If you have more tradelines on your record than the FHA or conventional lenders need, then you meet minimum requirements. This does not mean that you have optimized your credit. Take a look at your total credit limit (the total amount of money that your lines of credit say that you can borrow). Make sure that you are using no more than 30 percent of your allowable credit. If you are charging more than that percentage, pay it down or open a new line of credit until you meet the standard. Ideally, your record will show that you are paying off your credit bills in full every month.

If you have to open a new tradeline, do not do so with a retail store credit card. This does not help with your qualification even if you pay it off in full every month. Make sure that your new tradelines come from a major credit card (one that has a Mastercard or Visa logo in the corner of the card). Paying off the line in full every month still applies here, so be vigilant.

Prioritizing Credit Lines

Older lines of credit are worth more to mortgage lenders than new lines. The older your credit lines are, the more they boost your credit score. Make no mistake - this magic number is the secret to getting your way in the real estate market.

For instance, if you have seven credit cards and you only use two of them, closing the other five will not necessarily raise your credit score. Keep in mind that your total credit lines shrink every time you close down an account. If you close too many without paying off the rest, then your record may show you borrowing more than the 30 percent limit mentioned above. What's more, your unused accounts are considered good accounts by mortgage lenders. They may actually add to your credit score.

Be Careful Opening New Lines of Credit

Older lines of credit help you the most, and new lines do not necessarily hurt you. But they can, so be careful so how you open them if your strategy includes expanding your credit with new tradelines. If you open to many cards, you can temporarily lower your credit score. This is only temporary, so you may be able to strategize a better score if you have a bit of lead time before you actually want to begin pursuing your bank loan. If you don't have more than 12 months, however, you may want to find an alternative to opening new lines of credit.

A better alternative is to use your older lines of credit more often and pay them off every month in full. Ideally, you are using those accounts once every two to three months. This will tag the accounts as "active" to mortgage lenders and keep them adding to your all-important credit score.

Credit bureaus have no evidence to prove how you will handle new lines of credit. If you do not have six months to let your new tradelines become "old," then you may be better off leaving them unopened. Under no circumstances should you use a retail credit card to implement any of these strategies.

Paying Down Your Accounts

If you begin paying down your credit accounts to get your numbers looking better, focus on it and pay them down quickly. Make more than the minimum payment if you cannot pay off the loan in full on every account. If you have a history of minimum-only payments, you are not really given any informal credit by your home loan assessor. Your formal credit score will probably not go up, either. Why? Most commercial loans are structured so that the minimum payment does not begin to pay down the principal for some time. 

You are basically paying interest only if you pay the minimum, which is not a good financial strategy even if you aren't buying  a house.

Do Not Furnish a House that You Haven't Bought Yet

Buying a home is not like buying an extra dessert after dinner. You do not get any credit from the lending institution just because you are trying to get some extra furniture or appliances before closing. Taking out new credit to do this may ruin your ability to get the home!

Make sure that you are using cash to furnish your home if you need new furniture or appliances. Otherwise, just wait until you have cash. If your financial stats change unexpectedly before the close, you may lose your qualification. Because a great deal of this process is done by computer, this disqualification will be automatic. There will be no person to appeal to - your bank will just simply refuse to talk to you, and that will be that.

Car Loans and Vacations

Many people also mistakenly believe that getting a car loan is somehow exempt from the above criteria. It isn't! Buying a car on credit before close can ruin your home purchase. Don't do it. Don't do even if your lending institution lets you qualify! It is very possible that you can qualify for the car loan, and at the same time, your home loan is being disqualified.

Put off the vacation until after you buy the house if you are buying the vacation on credit. Even a few thousand dollars may affect your ability to qualify for a home loan. Humans at the bank may understand that you need a vacation, but humans may not make the decision for you. Keep in mind that you have to get past the automated algorithms of the bank computers as well. The computers don't see your expense as a vacation. They see it as an outlier expense that pegs you as a financial risk.

Moving Money Around Does Not Work

Because there is a time factor in looking at your cash accounts to ensure the veracity of your banking records, moving money into an account to look more liquid than you are will not work. Your bank will ask you to provide several months of your bank records. If the bank sees that you have huge transfers into an account right before the home buy, they will investigate. They will find the paper trail and react accordingly, meaning that you will probably lose the loan if you transferred money into that account from another account just to look good for the loan officer.

Once you have decided to buy a home, put an informal freeze on all of your accounts for at least three months. You can accept deposits and pay bills as you would normally, but do not make any "sudden financial moves" within this three month period. In short, if you haven't done it before, don't start doing it now. 

Not moving money around includes consolidating credit or shifting balances back and forth between your active credit cards. The activity only makes you look bad, and on top of that, you are probably charged a flat fee every time you do this. The extra cost that you incur will not outweigh the benefits, because your loan officer (or his computer) WILL find the paper trail. Don't try to outwit the system.

Give Yourself Time

No matter the path you are taking to fix your credit, it will not be done overnight. Give yourself at least six months to get all of your ducks in a row. Banks do not like to see any sudden financial moves in the months before you buy. Six months will give you time to pay down accounts, open new tradelines and fix any errors on your credit report.

Time is the key to a great credit score and a history of good credit. There is no way around this. Do not do business with any credit repair organization promising you different. They do not have the power to get you approved, and anyone giving you a guarantee of approval is trying to scam you. 

Getting the Cash You Need

Getting great credit by having credit is the majority of the battle. However, the battle is not yet won. Having REALLY great credit means having some cash on hand. Your bank loan officer wants to see that you have the cash to EASILY cover the fixed costs of buying a home. The down payment is the most important metric here, but it is not the only one. Even if you qualify for a no down payment loan from the FHA, for example, you still need cash for other things (emergency account, furnishing the home, home insurance, etc.).

Ideally, the bank wants to see that you have at least 20 percent of the price of the home in cash as a down payment. This down payment gives you equity in the home and shows the bank that you share the risk of the mortgage with the bank. If you do not have 20 percent, you may be on the hook for expensive Private Mortgage Insurance (PMI). PMI is an extra cash payment that your bank may demand of you to reduce its risk profile if you do not have the cash for an appropriate amount of equity.

Don't believe the hype - you cannot skip the home inspection and you should have the cash for an independent audit of the home that you want. Your bank will not require this of you in most cases. However, it is just good business. If you buy a home without inspecting it, you may very well have to sell it at a loss or spend good money repairing it. Neither option will be good for your credit down the line.

The cash you have also helps create your borrowing profile. Ideally, the monthly mortgage payment you take on should be no more than 30 percent of your monthly income. Your bank may use this metric as a benchmark to help decide your home loan fate. All else being equal, meeting this metric will help you qualify. 30 percent is also a well tested benchmark that you should personally trust. If you spend more than 30 percent of your income on your mortgage, then you may not have enough money for the fixed costs that are always associated with owning a home (unexpected repairs, scheduled maintenance, etc.).

Getting Pre-Qualified

Look at the pre-qualification process as a free mentorship program from the bank. It is a dry run of the real thing - you will have to turn in all of your paperwork, and you will receive a response from the bank. However, you do not have to go through a real credit check (which lowers your credit score, by the way), and nothing goes on your permanent record if you "fail" the test.

Get together your paperwork and follow the steps above to improve your credit as much as possible. Go through the pre-qualification process. Your bank will tell you, without dinging your credit, the mortgage amount that you are likely to qualify for. Once you have this number, you can begin thinking about how to improve your stats to meet the number that you want. If the number looks good, then you can confidently move forward with the mortgage process.

The Home Inspection

Getting an inspection from a dispassionate third party may help your credit indirectly. If the inspector finds a huge issue, then you may be able to negotiate the sell price with the seller. If you get the price lower, your down payment requirements go down. Your closing costs may go down. If the changes are significant enough, it may qualify you for a home loan when you would have otherwise been disqualified.

Take the best practices above to heart, and you may save yourself hundreds of thousands of dollars over the life of your next mortgage. Considering that great credit helps you in other ways, you are in a win-win situation. If you get discouraged, keep in mind that the rewards of your hard work will far outweigh the efforts you put in now. 

Credit is one of the best investments you can make in yourself. Make that investment now so that you can benefit down the road in many ways, including putting yourself in the house of your dreams!

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