Do you know your credit score? When it comes to consumer credit, many people turn a blind eye. But taking a “what I don’t know, can’t hurt me” approach to personal finance may present serious issues, particularly for first-time homebuyers.
We talked to NerdWallet® about how credit affects many different aspects of the homebuying process - from approval to interest rates—and why your credit score should never be ignored.
The latest Home Buyer Reality Report from NerdWallet reveals that 39% of denied mortgage applicants pointed to poor credit history and low scores as the reason for being turned down, and more than 50% cited high debt-to-income ratios. In other words, as a consumer you might be carrying too much debt. While it’s impossible to avoid some debts such as bills, credit cards, or student loans, there are steps you can take to remain in good standing.
The first step to a successful home buying experience is being prepared, says Tim Manni, a NerdWallet mortgage expert.
According to our research, borrowers who don’t understand the mortgage process or don’t know enough about their own credit history tend to hit obstacles or be rejected when applying for mortgages, Manni continues.
That tells me borrowers aren’t doing enough research—on themselves or the mortgage process—before applying for a home loan.
Applying for a mortgage puts your credit score front and center. Your lender relies on this score to determine your loan eligibility and the interest rates you will pay. The lower your credit score, the more you’re going to pay over the lifetime of your loan and vice versa.
That’s why it’s so critical to understand the loan process, research your options and take the time to get prepared. In this Q&A, we asked NerdWallet to further clarify how and why a good credit score is so important for prospective homebuyers.
In your Home Buyer Reality Report, 39% of denied mortgage applicants cited credit history and low scores as the reason. Why do you think so many people are unaware of their credit standing?
NerdWallet: I think it all starts with the fact that people don’t do the proper research on it. Or they don’t have the proper understanding of what has happened, or how it affects them. Maybe it’s a behavior they have that they don’t know is affecting their score. Part of the solution goes back to the old way of managing credit.
A lot of people are too scared to get their credit score—but you have to know what is hurting you. NerdWallet makes it really simple for people to learn their credit score. Without going to a site like NerdWallet and then seeing what’s in your report or black mark on your credit, it can be an ugly surprise.
It’s certainly our job to educate people. I think if you ask the average potential homebuyer, “What is a good credit score?” they wouldn’t know.
To really qualify for the best mortgage rates, you’ll want to get to 740. If you’re under 620, it’s going to be hard or more expensive to qualify for any mortgage, even an FHA loan.
What are some steps first-time homebuyers should take to shore up credit before applying for a mortgage? How long should they wait before beginning the application process?
NW: The first thing you want to do is establish where you stand—do a credit check. You’ll need to see if there any errors or disputes in your credit report. You want to get your baseline. You might not have a lot to do to improve your score—or you might have a lot of work to do. Another step is to get some understanding of how your credit score works. Learn what things and actions comprise your FICO.
When you’re getting ready to apply for a mortgage, you want to do everything right. You don’t want to do anything to ding your credit. People mistakenly believe they should close their credit cards, for example. If Tim has a $10,000 credit limit on his credit cards and he is only using $1,000, that’s a decent credit utilization ratio. But if he only has $2,000 [as a limit], that increases the credit utilization ratio.
Another tip is just paying your bills on time and in full. Sometimes that’s the one thing that makes up the most of one’s increases. Getting the credit card bill down to zero every month, but also showing lenders that you can pay down the debt. That shows them your credit cards are a convenience and not a crutch.
Stay away from new debt. You don’t want to set up any new accounts. Opening a store credit card to get a new flatscreen is bad news—especially right before your application, or even after your application. If you begin the application process, and you say you need that new sectional couch, that could count against you later. Your mortgage lender may check your credit throughout [the application process]. It also shows a kind of behavioral pattern when you’re in the process of applying.
Many Millennial buyers worry about the impact of high student loans will have on their approval. What should people know about student loans and buying a home?
NW: This is something that is very prevalent. More first-time homebuyers are saddled with debt and lenders know this. My biggest piece of advice is not to load up on debt. There are certain debts that lenders allow you to have. Sometimes the things you do to try to better yourself are the ones that count against you the most, most notably education.
For some people, their incomes may be sufficient enough to pay a mortgage but they suffer from bad credit history. How do lenders generally view these applicants?
NW: Credit scores don’t lie. If what has happened to you is history and you’ve recovered, then it’s in the past. That shows that someone has been reestablishing their credit. It’s rare for someone who has high debt to get a mortgage—even with a high income. If you have high debt, if your credit score is strong, if you put a lot of money down, that will help make the lender feel better. So will having a lot of cash reserves.
When you have debt there are certain things you can do to improve it. When the credit history isn’t good, then lenders have no choice but to judge you on your past behaviors.
What happens during the mortgage approval process when one partner has sufficient credit, but the other has a low credit score?
NW: If both partners are applying for the mortgage, the lender will take both borrowers' credit scores into account. If one borrower has sufficient credit and the other has poor credit, the lender will judge both borrowers based on the lower score. Lenders pull your scores from the credit bureaus. They will use the middle score. If there is more than one person on the application, the lender will use the lower middle score.
On TV, credit repair companies promise a quick fix to credit issues. How valid are these services, and should a potential mortgage applicant consider using them? What about lender-offered programs?
NW: Credit repair has a bad reputation for a good reason. Companies over-promise and under-deliver, or encourage people to commit fraud—and that's when they don't simply disappear with your money. There are some legitimate credit repair outfits, but the fact that a company can afford a TV advertisement doesn't mean you're going to get good results.
There are two recommended approaches here. If you have bad credit because you've handled credit badly, then repairing it will take time. It's totally possible to do, but it's not going to happen overnight.
If, on the other hand, your credit report has mistakes in it that you have already corrected and that keep coming back, or that you can prove are mistakes, you may benefit from what's called rapid rescoring. This is a service offered by the credit bureaus to many mortgage lenders and brokers. It's not available directly to consumers. The lending pros that offer it will take your paperwork proving the errors and work with the credit bureaus to get your reports updated so you can get a mortgage.
Most of the free credit score reports offered on various websites, including the free report from NerdWallet, are VantageScore 3. These offer a good way to monitor your credit in general. Some places, including Experian, offer free FICO 8 scores. That is the score that's most often used by lenders. However, the actual score your lender uses may be different. FICOs are tweaked for different industries and have different generations, kind of like operating systems on a computer.
If people are getting a mortgage, I recommend that they pay for the full suite of their scores from MyFico.com. It's $20 per bureau, so $60 for all three bureaus, but you get the bureaus' five or six most commonly used scores, including mortgage scores. Again, you still may not see the exact same scores your lender may use, but you'll be in the right ballpark.
Should people take out personal loans to pay off debts in order to apply for a mortgage later?
NW: Taking out a personal loan to me is a slippery slope—it’s essentially robbing Peter to pay Paul. If you take on new debt to pay old debt, your lender is going to see you’re relying on debt to pay debt.
If anything sounds too good to be true, it usually is. You can’t beat the tried and true method. Take some more time. Maybe now is not the right time to take on a mortgage.
Still have credit questions?