Your credit score is one of the most critical factors measured when banks determine whether or not you’re eligible for a home loan. Additionally, your credit score is considered when offering mortgage terms. The better the score, the better interest rates you’ll receive.
If your goal is to purchase a house in the next few years, it’s time to start building your credit. Here are some actionable tips to help you get your credit in shape before applying for a home loan.
Review Your Credit Score and Report
First, take a look at what you’re working with. Your credit score is a snapshot of your borrowing habits; the credit report provides the details. Many people avoid pulling their credit report because they believe it will impact their score. While having a lender run a credit check will affect your credit score, drawing your own report for review will not.
Take some time to review what items are impacting your score. Some of the most common negative items found on a credit report include:
- Missed and late payments
- Hard inquiries (when a lender pulls your report)
- Collections
Your debt ratio is another factor that influences your score but doesn’t show on a report. This element evaluates how much you’re approved to borrow versus how much you actually borrow. In other words, if you have a line of credit with a $10,000 maximum and you only owe $2000, your credit score will be higher than if you owed $5000. This feature can sometimes be used as a loophole to boost your credit score as you pay down debt.
Dispute Negative Items
After you’ve reviewed your credit report, start disputing negative items that don’t belong. These items include debts that have been sold to new collectors, items past their statute of limitations, and fraudulent items. Take some time to understand what you can do about a medical collection account, how the verification process works, and your rights as a borrower.
For example, collectors aren’t allowed to call you at unreasonable hours and must stop calling your place of employment upon request. Failure to comply creates grounds for removal. Additionally, medical collectors must comply with HIPPA regulations regarding sharing private information. If they don’t comply, you can push to have the item removed.
Audit Your Spending
Most people try to adhere to a budget while overlooking an essential first step: understanding current spending habits. In our digital era, it’s easy to lose track of how much we’re mindlessly spending. You might think you’re only spending a few dollars a week eating out, then determine that it’s actually hundreds of dollars a month.
Audit your spending and determine where to make small cuts to create a budget. Then, create small sustainable habit changes. I.e., cut back to one take-out day per week rather than three.
Pay Down Debts
Paying down your debts offers several benefits when boosting your credit score. As mentioned previously, your debt ratio is an important factor in your overall score. Improving your debt ratio by paying down debts helps tremendously— just remember not to close the account so that the ratio remains intact.
Consider using a debt payment strategy to eliminate your existing debts, such as the debt snowball or avalanche. You can also talk to a financial advisor about consolidation.
Set Savings Goals
There’s a common misconception that you should pay off your debts before you start saving. On the contrary, building savings habits is something to start right away. If your focus is on paying down debt, allocate a small amount to savings that you would spend elsewhere (for example, on eating out). Once the debt is paid down, reallocate more money to build up your savings.
Building savings doesn’t directly impact your credit score, but it helps you avoid using credit if an emergency arises and protects your progress.
With these actionable steps, you can improve your credit score and achieve your goal of buying a home.
