When it comes to buying a home, your credit score is a crucial factor that lenders consider. However, numerous myths surround credit scores and their impact on purchasing a home. These misconceptions can deter potential buyers from pursuing their dream home or lead to costly mistakes. This blog post aims to clear up these myths, providing you with the accurate information you need to navigate the home buying process effectively.
Myth 1: You Need a Perfect Credit Score to Buy a Home
One of the most daunting myths about buying a home is the belief that a perfect credit score is necessary to secure a mortgage. This misconception can prevent many potential buyers from even exploring their home buying options. However, the truth is much more accommodating.
A “perfect” credit score is typically considered to be 850, but in reality, very few people achieve or maintain this score. Lenders are aware of this and thus do not expect perfection. Instead, they use a range of credit scores to determine eligibility and the terms of the loan, including the interest rate. For conventional loans, many lenders look for a credit score of at least 620, while FHA loans, which are insured by the federal government, may allow credit scores as low as 580 with a 3.5% down payment.
Moreover, lenders consider other factors in addition to your credit score. This includes your debt-to-income ratio (DTI), which helps lenders evaluate your ability to manage monthly payments and repay debts. Your employment history and the stability of your income also play significant roles. Lenders use this comprehensive view to assess your overall financial health and reliability as a borrower.
For those whose scores fall below typical requirements, there are several steps that can be taken to improve one’s credit standing. These include paying bills on time, paying down debt, and correcting any inaccuracies on your credit report. Additionally, some lenders specialize in “subprime” mortgages and work with clients who have lower credit scores, although these loans may come with higher interest rates and additional lending fees.
Finally, many homebuyers benefit from state and local first-time homebuyer programs and grants, which often have more flexible credit requirements. These programs can also offer down payment assistance or favorable loan terms, making homeownership more accessible to more people.
Understanding that lenders use a broad spectrum to evaluate potential borrowers can alleviate some of the anxiety associated with the mortgage process and encourage more prospective buyers to pursue homeownership.
Myth 2: Checking Your Credit Score Will Lower It
A common concern among potential homebuyers is that checking their own credit score might negatively impact their credit rating. This myth arises from a misunderstanding of how credit inquiries affect your credit score. Understanding the difference between “hard” and “soft” inquiries can clear up this misconception and encourage you to monitor your credit without fear.
Soft Inquiries:
When you check your own credit score, the inquiry is considered a “soft” pull. Soft inquiries also occur when companies check your credit for pre-approval offers of credit or services, and when employers check your credit as part of a background check. These inquiries are not linked to a specific application for new credit and, therefore, do not affect your credit score at all. They are simply a way to verify your current credit status without any implications for credit applications. Because of this, you can and should check your credit score regularly. Regular monitoring is crucial for understanding your financial standing and ensuring your credit report remains accurate. Spotting errors and addressing them promptly can help you maintain a healthy credit score.
Hard Inquiries:
A hard inquiry occurs when a financial institution checks your credit as part of a lending decision, like when you apply for a mortgage, a car loan, or a credit card. Hard inquiries can affect your credit score because they are recorded on your credit report and reflect new potential debt that doesn’t yet show in your credit report as actual debt. However, a single hard inquiry will typically only lower your credit score by a few points. Furthermore, the impact of hard inquiries on your credit score diminishes over time. Most hard inquiries stay on your credit report for two years, but their effect on your score decreases or disappears well before they fall off your credit report.
Rate Shopping:
It’s important to note that most credit scoring models recognize when you are rate shopping for certain types of loans, such as a mortgage or an auto loan. If you make multiple inquiries for the same type of loan within a short period (typically 14 to 45 days), these are usually counted as a single inquiry for the purpose of calculating your score. This allows you to shop around for the best rates and terms without worrying about multiple hard inquiries negatively impacting your credit score significantly.
By understanding these distinctions and managing your credit inquiries wisely, you can take control of your financial health without the undue stress of mistakenly believing that merely checking your credit score could undermine your creditworthiness. Regularly reviewing your credit report empowers you to prepare effectively for future financial undertakings, such as applying for a mortgage when purchasing a home.
Myth 3: Closing Old Credit Accounts Will Improve Your Credit Score
A prevalent myth among many consumers is that closing old or unused credit accounts will positively impact their credit score. This belief stems from the notion that fewer open accounts signal less potential debt, making one appear more financially responsible. However, the reality is often the opposite, and closing these accounts can actually harm your credit score in several ways.
Impact on Credit Utilization
One of the key factors that influence your credit score is your credit utilization ratio, which is the amount of credit you are using compared to your total available credit. This ratio accounts for approximately 30% of your credit score. When you close an old account, especially one with a high credit limit, you reduce your overall available credit. If you carry balances on other cards, this suddenly increases your credit utilization ratio because you have less available credit overall. A higher utilization rate can signal to creditors that you’re inching closer to maxing out your credit lines, which negatively impacts your score.
Effect on Credit History Length
The length of your credit history contributes to about 15% of your credit score. Creditors like to see a long history of responsible credit use. When you close old credit accounts, particularly those you’ve maintained in good standing for many years, you may shorten the average age of your accounts on your credit reports. Older accounts add depth to your credit history and provide a more extended track record of managing credit responsibly.
Considerations Before Closing Accounts
There are scenarios where closing an account might be advisable, such as those involving high annual fees or poor terms that no longer serve your financial strategy. If deciding to close an account, consider doing so with newer accounts rather than older ones to minimize the impact on the length of your credit history. Also, aim to close accounts gradually rather than all at once to lessen the immediate impact on your credit score.
Better Alternatives
Instead of closing accounts, you can simply reduce your usage of them while keeping them open. This approach helps maintain your long credit history and low utilization ratio. Periodically use these accounts for small purchases that you can pay off immediately to keep the accounts active, as issuers may close inactive accounts.
By understanding these dynamics, you can make more informed decisions about managing your credit accounts in a way that supports or enhances your credit score, rather than inadvertently damaging it. Keeping old accounts open, especially those with a positive payment history and high credit limits, can be a beneficial strategy for your credit health, particularly when you’re considering major financial decisions like buying a home.
Myth 4: You Can’t Improve Your Credit Score Quickly
A common belief among many prospective homebuyers is that improving a credit score is a lengthy process, taking months or even years. While it’s true that building a robust credit history doesn’t happen overnight, there are several steps you can take that can have a relatively quick impact on your credit score. Understanding and implementing these strategies can expedite the improvement of your credit health, potentially making a difference in your mortgage options and interest rates.
Pay Down High Balances
One of the fastest ways to improve your credit score is to reduce your credit utilization ratio, which is a major factor in credit scoring. If you have any credit cards or lines of credit that are close to being maxed out, paying these balances down can lead to a noticeable improvement in your score. Ideally, try to keep your credit utilization below 30% of your limits on each account, and even lower if possible.
Rectify Credit Report Errors
Another quick method to potentially boost your score is by checking your credit reports for errors and inaccuracies. Common issues include incorrect account statuses, balances, or even fraudulent accounts opened in your name. You can obtain a free copy of your credit report annually from each of the three major credit bureaus through AnnualCreditReport.com. If you find errors, dispute them immediately with the credit bureau. The correction of these errors can improve your score once the false derogatory marks are removed.
Set Up Payment Reminders
Since payment history is the most significant factor affecting your credit score, ensuring timely payments is crucial. Setting up payment reminders or automating your monthly payments can help avoid late payments. Even a few consecutive months of on-time payments can start to improve a poor credit score.
Become an Authorized User
If a family member or a close friend has a long history of responsible credit use and a strong credit score, consider asking to become an authorized user on one of their credit accounts. This can add their account’s history to your credit report. If it’s a long-standing account with a good payment record and low credit utilization, it can give your own credit score a boost.
Negotiate with Creditors
If you have any delinquencies or outstanding debts, try negotiating with your creditors. You can ask for a “pay for delete” agreement, where the creditor agrees to remove the derogatory item from your credit report upon receipt of payment. Not all creditors will agree to this, but it’s worth asking.
By taking proactive steps and utilizing these strategies, you can effectuate noticeable improvements in your credit score in a relatively short period. These quick adjustments can enhance your financial profile, making you a more attractive candidate to lenders and potentially leading to better mortgage terms when you decide to buy a home.
If you’re planning to buy a home and want to know more about how your credit score will affect your mortgage options, get in touch by clicking the button below to book a free mortgage consultation with us. At The Orlicki Group, we’re committed to helping you understand your financing options and finding the best solution for your needs.
You have the right to obtain a free and secure Credit Report at www.annualcreditreport.com. The top three credit reporting agencies, Equifax, Experian, and TransUnion are required by law to provide you with a free annual credit report, once a year.
Credit problems? Fixing credit reporting issues , such as incorrect collections showing up, late payments showing up when paid on time, active accounts that are closed, can be fixed. The key is to identify any issues and work toward having them corrected. If you want to take action, get in touch with us and we can connect you with our preferred credit repair provider My Credit Guy.
Equifax- 1-800-685-1111 or go to www.equifax.com
Experian- 1-888-397-3742 or go to www.experian.com
TransUnion- 1-800-916-8800 or go to www.transunion.com
