Buying a home is equal parts excitement and headache.
It's exciting because it may be the biggest purchase you've ever made. But at the same time, it seems like there are just so many hoops to jump through.
Passing the lender's credit check is a big one.
It's a little unnerving having a total stranger sift through your financial history, especially if your credit score isn't that great.
In the spring of 2016, I decided to buy a home after renting for the previous two years. I used a mortgage broker and when they pulled my credit reports, it was pretty much what I'd expected.
My credit scores were kind of all over the place -- one was in the 630s, another was in the 660s.
These scores lie in the "fair credit" category.
If you've never bought a home, here's a little tidbit you'll want to know: lenders base mortgage approval decisions (and the terms you get on a loan if you're approved) on the middle of your three FICO credit scores.
In my case, my middle score was a solidly underwhelming 640. Considering that the minimum credit score required for conventional loans is 620 and for FHA loans, it's 580, I knew I could get a mortgage.
But I was worried about something else: my interest rate.
Why Home Buyers Should Care About Interest Rates
Banks don't go around lending people hundreds of thousands of dollars to buy houses for nothing; they charge interest for that service.
Your interest rate is super important when getting a mortgage because it determines how much buying a home really costs.
Even a small difference in your mortgage rate could mean paying significantly more in interest over the life of the loan.
For example, say you get a $250,000 mortgage at 4.5 percent. With a 30-year loan, you'd pay just over $206,000 in interest total. If your rate creeps up to 4.6 percent, that raises the amount of interest paid to more than $211,000.
A difference of a full percentage point in your rate would mean paying over $260,000 in interest. That's more than you originally borrowed.
You may not be aware of the cost unless you actually do the math because you're paying your mortgage over time, but that's a lot of money to part with.
Interest rates matter in a big way when you're buying a home -- and so do your credit scores.
While it's not the only thing that lenders use to set your loan terms, it's a big one.
Getting a Mortgage With a 640 Credit Score
When I decided to buy a home in 2016, I originally wanted to apply for a USDA loan. This is a zero-down payment mortgage option for people living in rural areas.
I knew this type of loan had a 640 minimum credit score cutoff so I thought was okay there.
I had too much in savings to qualify for it so I had to regroup.
I ended up going with an FHA loan because I wanted to make the smallest down payment possible. (FHA loans only require a 3.5 percent down payment if your credit score is 580 or better.)
There were a few bumps during the underwriting process -- being a self-employed freelancer means mortgage lenders take an extra close look at your finances. But eventually, I got the green light for a home loan.
All I had to do was wait for my mortgage broker to lock in my interest rate.
At the time, the Federal Reserve hadn't ramped up its rate hike strategy so mortgage rates were still near historic lows. That was great for me, because I was able to get a 3.25 percent rate on my home loan, even though my credit score wasn't a perfect 850.
(Remember, the score my mortgage broker ended up using was the 640 one in the middle.)
That low rate kept my payments low. In fact, my mortgage payment is actually less than what I was paying as a renter and it includes the escrow for my homeowner's insurance, property taxes and the mortgage insurance premiums that are required with FHA loans.
In my case, waiting a little longer to buy so I could improve my credit score may not have made much difference to my interest rate, since rates were already low.
In the last two years, however, mortgage rates for a 30-year loan are over one full point higher than they were when I bought my house.
There's a chance that rates will climb again once or twice in 2019.
If you're planning to buy a home now, you need to pay extra close attention to your credit score to make sure you're getting a good deal on a home loan.
Credit Score Tips for Would-Be Home Buyers
Buying a home takes some prep work, starting with figuring out how much home you can afford to buy.
This step is really important because setting a home buying budget can help you make the best decision about which kind of mortgage to get. It can also help you figure out how much you'll need for your down payment and closing costs.
Once you tackle that, you can turn your attention to your credit.
If I were going to buy a home all over again (and I'm hoping to buy another this year), here's exactly what I would do to make sure my credit scores were as strong as possible before applying for a mortgage:
Check your credit reports early
Your lender's going to look at your credit reports so it makes sense for you to do the same.
Pull all three of your credit reports (you can get them for free at AnnualCreditReport.com) and go over all the information to make sure everything is correct.
If you see an error or mistake, dispute it with the credit bureau that's reporting it to have it corrected or removed. That could raise your score slightly.
Also, look for negative information on your credit reports, like late payments or accounts that have been charged-off or sent to collections.
Be prepared to explain those to the lender in writing since they'll ask for that during underwriting.
Break down what's in your credit score
Your FICO credit scores, which are what most mortgage lenders go by,
If you're not well-versed in credit scores and credit scoring, take time to learn how each one of these factors affects your credit score.
Then tailor your credit habits so you're doing things that can raise your score and avoiding things that could take points away.
(Here's a hint: paying your bills on time is the single most important thing you can do to help your credit score.)
Stop opening new credit accounts
In the grand scheme of credit scoring, opening new accounts is a smaller thing than say, paying your credit card bill late.
But every time you apply for new credit, it shows up on your credit score and knocks off points.
Last time around, I opened a new credit card account a couple of months before applying for a mortgage. I wouldn't do that again because the loss of even two or three points could affect my credit score and the interest rate I'd qualify for on a mortgage.
Unless you absolutely have to get a new loan or credit card account, you're better off waiting until the ink is dry on your mortgage documents.
Bump up the limits on your credit cards
Credit utilization is a term you may want to familiarize yourself with if you're planning to buy a home.
All it means is how much of your total credit limit you're using at any given time.
Some experts say that you shouldn't use more than 30 percent of your available credit but if you really want to improve your score, 10 percent or less is better.
There are two ways to improve your credit utilization:
- pay down your debt
- increase your credit card limits
Paying down debt is preferable because less debt means less strain on your budget.
Lenders also look at how much of your income you're spending on debt repayment each month. If it's too high, typically more than 36 to 45 percent, then you'll have a hard time getting a home loan.
But paying off credit card debt isn't always a fast process, especially if you also have student loans or a car loan.
Raising your credit limits can be an easier fix to improve your credit utilization.
Many credit card companies let you request a limit increase online. You just plug in your household income, they check your account history and you can have a decision in under a minute.
If that's not an option, you can always call up your credit card companies and ask for a higher limit. Just remember that this tactic only works if you're not adding to your credit card debt.
A good rule of thumb:
Put your credit cards away altogether until after you've bought a home so you're not working against yourself.
Don't Panic If You Don't Have Perfect Credit
I speak from experience when I say that having a below average credit score won't shut you out of buying a home.
It could make it a little more expensive, however, if it means getting a higher interest rate.
The good news:
You can continue working on your credit score after you buy.
And, you could always refinance down the line to get a lower rate.