By the numbers, 74% of Americans have homeownership listed as their number one priority in life. If you’ve been thinking about buying a house, it’s safe to say that you’re in good company.
But even before keys can change hands and move-in dates can get approved, there’s a hurdle that 99.9% of homeowners have to navigate:
Credit. Or more specifically, having the kind of credit that makes lenders review your application and say, “We can definitely approve this borrower!”.
If your recent Google searches include phrases like, “How to fix my credit to buy a house” and “how can I repair my credit?”, you’re in luck. I’m about to break down everything you need to know about repairing and rebuilding your credit until it’s strong enough to sail through the mortgage approval process. Keep reading to find out more.
The 2 Ways Credit Affects Your Home Purchase
With so many companies pushing loan advertisements that say things like, “All credit approved!” and “Low credit? No problem!”, you might be wondering if rock-solid credit is all that it’s cracked up to be. When it comes to your home-owning ambitions, however, there are a couple of strong reasons to get your credit as high as possible:
1. Your Credit Affects Your Offered Rate
Put yourself in the shoes of your lender. Your job doesn’t just depend on being able to identify potential borrowers — you need to find low-risk borrowers. And when you’ve got borrowers who are a bit more likely to default than others, you need to find a way of offsetting that increased level of risk.
Good credit is like holding up a neon sign that says, “I’m a low-risk borrower! You can lend me money and I will pay you back!”. And lenders will often respond by giving these borrowers a lower interest rate.
But you don’t have to take my word for it.
Business Insider reported that Americans with credit scores between 660 and 719 paid an average credit card interest rate of 16.9%. Meanwhile, people with credit scores of 579 or lower were paying 21.1% in interest.
The same logic applies to larger loans like mortgages. And when the borrowing amount is sitting at a healthy six figures, these percentage points can add up to a significant chunk of additional interest payments that are coming out of your pocket.
Or to put it another way, strong credit makes it possible for you to save thousands on your mortgage.
2. Your Ability to Get Approved
Sometimes the issue for lenders isn’t how much interest to charge based on credit-related risk factors. It’s about whether to approve your application at all.
On a human level, there’s nothing worse than finding your dream home, negotiating with sellers, and then having to withdraw an offer because you can’t get your mortgage approved. And in a competitive housing market, non-approvals can make it nearly impossible to purchase a house.
Once that happens, you generally have two options:
- Give up your home search
- Find alternative lenders
When you’ve got stellar credit, you don’t have to sit around the kitchen table while making these difficult decisions. Why? Because your preferred lender will be more likely to approve you.
What Causes Bad Credit?
Many Americans aren’t financially irresponsible people. They don’t live outside of their means or rack up credit card debt like it’s going out of style. But they nonetheless have less-than-ideal credit.
What are credit bureaus and lenders evaluating? How do financially stable people end up with subpar credit? Here’s a list of five factors that can lead to credit issues:
1. Missed Payments
In the first part of 2022, home prices were sitting at a median price of $428,700. If and when these prices go down in the future, that still won’t change the fundamental fact that your mortgage will probably be hands-down the largest loan that you ever apply for.
Even when you’re only trying to borrow a few thousand dollars, lenders will be using your credit history to answer a fundamental question:
Will this borrower pay us back?
And when you start borrowing mortgage-level sums, finding an answer to this question becomes all the more important for your future lender.
Your payment history can tell creditors a lot about how you’ve prioritized your payments in the past. For this reason, they care deeply about how often you’ve made your payments.
Mistakes happen. And when you’re caught up in a major project at work, it can be easy to forget about that credit card payment. But because payment history is far and away the most heavily weighted factor in your credit score, a habit of missing payments can take several years to fix.
2. High Outstanding Balances
Speaking of factors that have a huge effect on your credit score, here’s another one that you can’t afford to overlook if you want to improve your credit:
The amount of credit you use relative to the amount of credit you can borrow. This issue isn’t just about raw dollar amounts – it’s about percentages.
Here’s an example of what I’m talking about.
Let’s say you’ve got a credit card with a $500 limit. If you’ve spent $450 on the month, you’ll have used up 90% of your credit. And because lenders like to see a credit utilization rate of 30% or less, that $450 balance could sink your credit score like a stone.
Meanwhile, the person who’s spent $3,000 on their $10,000 line of credit could be sporting a mortgage-ready credit score.
This might sound a bit counterintuitive, but lenders attach weight to this detail because credit checks are designed to identify signs of potential financial distress. All things being equal, you don’t want to loan significant sums to someone who’s struggling as it is.
As a result, carrying high balances doesn’t just give creditors pause – it can gradually decrease your credit score.
3. Applying for Too Many Credit Products
Remember what I said before about how signs of financial stress can hurt your credit score? In some ways, this credit-sinking series of actions is a continuation of the same logic.
If you’re like many Americans, you may find it easier to handle all of your financial matters at once. You’re buying a new house already, so why not buy a new car and extend your line of credit as well? Or maybe, you’re trying to increase your credit limit while paying off your existing debts.
Regardless, each creditor will do what’s known as a hard credit inquiry. And the more of these you have within a short timeframe, the lower your credit score will become.
4. Mistakes in Your Credit Report
If there’s one word that most people wouldn’t use to describe financial institutions, it’s “careless”.
You’re probably used to receiving bank statements that are accurate and meticulous. You’re used to seeing accurate account balances and timely updates.
But yet, 34% of consumers discovered that there were inaccuracies in their credit reports.
This doesn’t always look like all the usual cases of mistaken identity. Maybe an account you already paid off is showing the balance from six months ago. Maybe your payments were reported as late when you paid on time.
Requesting and reviewing credit reports is no one’s idea of a good time. And in many cases, it might even feel like a waste of time because banks and creditors are often so meticulous with their recordkeeping that there aren’t any problems in the credit report.
But even so, it only takes one inaccurate report to destroy a person’s credit score.
5. Lack of Awareness
It’s been said that 40% of Americans don’t know the annual interest rate they’re being charged. Of course, if you’re paying your balance off in full every month, this information might not be relevant. But if you’ve gone through phases where money has been tight, the annual interest rate is essential to know.
When it comes to your current credit-related debts, it’s not enough to guesstimate or search for ballpark figures. You’ll want to account for every outstanding balance down to the penny.
Answering the Question “How to Fix My Credit Before Buying a House”?
Now that we’ve covered the “why” and the “how” of credit, it’s time to talk logistics. I’ve offered credit-boosting advice to homebuyers before. But here’s a set of additional tips for people who would be homeowners if their credit wasn’t holding them back:
1. Create an Aggressive Debt Repayment Plan
Let’s say you’ve got a few open credit accounts with outstanding balances. And as you sit down and get ready for your mortgage application, you’re worried that your credit score will disqualify you off the top.
Here’s how you can improve your credit score in a hurry.
Do an audit of your credit cards and lines of credit. And then take a closer look at your monthly expenses.
Are there subscriptions you can cut? Have you been eating a little too much fast food lately? Even switching from name brands to generic alternatives can help you end the month with more money in your bank account than usual.
As you pay down your debt, you’ll be able to lower your credit utilization ratio and increase your score.
2. Consider Buying a Smaller House
Sometimes the difference between a “Yes” and a “No” on your mortgage application is your requested borrowing amount. It all goes back to what I said before about how lenders often take a cautious approach to risk.
In some housing markets, you’ve got a baseline number to meet. But in others, you may be able to find comparable houses at surprisingly affordable prices.
Maybe the seller is trying to move in a hurry. Perhaps you’ll have to go with a half bathroom on the main floor instead of a full one. Or maybe the square footage will turn out a little bit smaller.
But either way, here’s the bottom line:
A lower price can help you maximize your down payment. And it can make lenders more comfortable with financing your purchase.
3. Don’t Close Your Old Accounts
While trying to shore up your credit, it can be tempting to cut up your old credit cards and start closing accounts. After all, if lenders like to see a low credit utilization ratio, how much better would a few responsibly used credit accounts look?
Like wine and certain types of cheese, however, credit accounts get better with age.
First, because creditors want to see that you have a solid track record. And second, because having those extra accounts can only help your credit utilization ratio.
In the run-up to your mortgage application, you’ll want to spend your credit carefully. But if you’ve got any accounts up and running, you’ll want to leave those open.
4. Get a Credit Coach
Personal finance is a tricky subject in the best of times. But when you’re trying to do credit repair on a deadline, you don’t have time to take a trial-and-error approach.
Think back to your school days. Would you have done nearly as well in calculus without a teacher showing you how to solve the equations? For most people, the answer is “No!”.
And with your mortgage application on the line, now is not the time to experiment.
If you want financial advice and customized credit solutions, I offer credit coaching to anyone who wants it.
Get Mortgage-Ready Credit the Easy Way
Now more than ever, financial savvy is an essential part of living life on your terms. But going from “I need to know how to fix my credit to buy a house.” to “Come and see my new house!” isn’t easy.
Want to get a comprehensive credit-building blueprint from a credit expert with appearances on CNN, The New York Times, Fox News, and more? Sign up for my masterclass!