Planning to buy a home in the near future? The sooner you get your money situation in shape, the easier it'll be to take on a mortgage loan. Here's how you can prepare your credit and finances for a future home purchase.
Pay Your Bills on Time
Focus on building your credit history. The best way to do this is to make sure you pay your bills and rent on time. According to Bankrate:
"'There is no single element that can so dramatically impact the success of an application as your credit history," says Brian Israel, vice president of Chicago-based Harris Trust and Savings Bank's residential mortgage division. 'Another thing, of course, is savings. People should have a good disciplined savings pattern. That's the kind of behavior that's going to make them a successful homeowner.'"
To develop a disciplined savings pattern, check out our post on how to start saving for a home down payment.
Also, make sure you pay your rent on time each month. According to Realtor, mortgage lenders want the last 12 months of cancelled checks if you're renting from a private landlord. If they see you've skipped a month, they'll consider it a "mortgage late." Realtor says this can hurt your chances of being approved. Also, make sure your checks are dated consistently around the same time each month.
Monitor Your Credit
Stay on top of your credit history and learn how to read and understand your credit report.
Look for inaccuracies, which can hurt your credit score and affect your future mortgage application. If there are any discrepancies, you'll have to dispute them with the credit bureaus. Here are some sample letters for filing a dispute.
Maybe you have delinquent accounts. These can be accounts that are late, charged-off, sent to collections, etc. These delinquencies can kill your chances of getting a mortgage, as lenders won't think you can make your monthly payments. Finance writer LaToya Irby suggests you pay off all delinquent accounts before applying for a mortgage:
"You need to establish a pattern of timely payments to get approved for a mortgage and get a competitive interest rate. If you have a recent late payment - or you've just paid off some delinquencies - wait at least six months before applying for a mortgage. The older the delinquency, the better your credit looks."
It's important to note that if you have toxic debt, it might be a sign that you're living beyond your means. If you have issues with overspending, it's important to deal with them before you decide to buy a home. The costs and responsibility of home ownership can be overwhelming if your money habits are out of control.
Have Three Trade Lines
Realtor says that most lenders want you to have at least three trade lines (credit cards, student loans, etc.) that have been open for at least a year.
"If you only have one card, open two more now. Your credit score may go down a bit, but you will probably need to wait a year to establish some credit history, so it will adjust back up soon."
Similarly, Daily Finance adds that closing accounts might be a bad idea.
"Closing a major credit card can actually do damage to a credit score. Lenders look at the balance on revolving credit accounts in terms of its ratio to total available credit. Closing an account can have the unintended consequence of raising the ratio."
Save and Increase Your Down Payment
A bigger down payment won't guarantee your loan approval, but it certainly helps. According toGlobal Post:
"The larger the down payment you come up with, the lower their risk. The theory goes like this: If you've already invested a large sum of money in your home, you'll be less likely to stop making payments if you suffer a financial crisis. You'll have, as lenders say, 'more skin in the game.'"
If you can find ways to do it, start saving more. Consider a savings vehicle that offers a reasonable return without being too risky.
Do Your Research
Research and understand the costs associated with home ownership. There will be property taxes and insurance. You might have higher utility bills or homeowner's fees. Maintenance, repair and decorating might also cost more than you think.
Similarly, you should research your mortgage options. Financial expert Liz Pulliam Westonwrites:
"A lot of people are losing their homes today because they didn't understand what kind of mortgage they had or they accepted bad advice. The low teaser payments that allowed them to buy a more expensive house have jumped skyward, leaving them unable to pay."
She suggests a traditional, fixed-rate mortgage.
Avoid Big Purchases
It's important to have an active credit history. But as you get closer to applying for a mortgage, it's time to cool it. Bankrate says you should avoid big purchases as you prepare to apply:
"First off, don't make any big purchases over the next couple of months. Besides the obvious fact that it makes less money available for the down payment, it might require you to get yet another loan."
They say that a large debt—a $15,000 car loan, for example—will look bad to the lender's scoring systems.
Shelve Credit Usage 45 Days Before Applying
Mint suggests you pay off your credit cards, and then not using them for at least 45 days before applying for a mortgage.
"Paying the cards off 45 days in advance is plenty of lead-time. You can continue to use your debit, prepaid debit, or gift cards because those don't show up on your credit reports."
If you think home ownership is in your future, plan to tackle it responsibly. Get your credit and finances in order today to make the whole process easier in the future.