Does it feel like qualifying for a home loan is becoming more difficult? Lenders have increased their scrutiny of mortgage applications , and although it might be more difficult to get a mortgage now than it was five years ago, the stricter rules that are in place have helped Americans get a better handle on their finances.
If you're looking to buy a home, it's important to get your credit and your debt under control first. According to Forbes, “in recent years, the number of consumers who have a top [credit] score (800 or above) has increased due to the fact that more individuals have cut spending and paid down debt in response to the recession.”
6 Ways to Build Credit Before Buying a Home
Building your credit is one of the first steps to financial health, and a must if you're thinking of buying a home. Having strong credit will allow you to get the best mortgage at the best rate, which means that you'll pay less interest on your home over time. Paying less interest leaves more money in your pocket for other aspects of your life (like starting a family, or saving for retirement).
Your credit report contains all the information used to calculate your credit score, a 3-digit number between 300 and 850 that gives lenders an objective assessment of your credit risk. The higher your credit score, the better.
1. Reality check
It's important that you know your credit score, your debt-to-income ratio, and have a realistic gauge of your overall financial health before you start the process of buying a home. Start out by getting to know your credit score and your credit report. You need to know your credit score before you can start building your credit. Check your credit report on a yearly basis and immediately correct any inaccuracies that you spot.
2. Use your status as a renter to your advantage
When you rent an apartment, you can use your strong rental history as a credit reference when you apply for a mortgage if your regular rental payments can be verified by a management company or landlord.
Consider paying your rent with a cheque or debit card so that your bank statements reflect proof of your payments. Also, try to stay in one place rather than bouncing from one apartment to the next. That consistency will be evident on your credit report and looked at positively by lenders.
3. Be picky about credit cards
It's important to build your credit, but not all credit cards build your credit in the same way. Avoid department store credit cards, which are looked at negatively by lenders and can even hurt your credit score (plus they usually have high interest rates, which means they're not a good avenue to use to build your credit).
Instead, stick to a trusted financial institution. Be sure to read the fine print on annual rates, fees and potential penalties.
As a member of BECU, you may want to explore our credit card: As a credit union, with no shareholders to pay, our members benefit from better rates and fees. In fact, BECU has one of the lowest rates in the nation.
4. Keep credit card balances low
Even if you haven't missed a minimum payment, if you max out your credit card it could hurt your credit rating. If you keep a balance, we recommend keeping it at one-third of your credit limit.
5. Set up auto-payments
A simple step like setting up an automatic payment on your bills and debts will help you ensure that you don't miss a payment. A missed payment can appear on your credit report and negatively impact your credit score.
6. Find a partner
It's important to look for a financial institution that sees you as a partner. At BECU we teach our members how to build better financial health. If you're looking for ways to build credit you can register for our webinar that will teach about credit reports, scores, and the doors that good credit can unlock for you.
Building your credit is important, but it's not the only factor that lenders will look at when determining your eligibility for a mortgage.
5 Ways to Reduce Debt Before Buying a Home
Reducing debt is another must-do when it comes to buying a home and increasing your financial health. In addition to your credit, lenders also look at your debt-to-income ratio (DTI), a mathematical formula used to measure your personal finances.
Your DTI compares your debt payment to your overall income. Expressed as a percentage, your DTI is used by mortgage lenders to determine whether you will be able to manage your monthly mortgage payment. A low DTI is good – it shows that you have a good balance between your debt and income. But, if this percentage is high, then it can mean you have an unhealthy amount of debt.
1. Create a realistic budget
The only way to reduce your debt is to stop spending more than you have. If you're having trouble cutting down on your spending, try keeping a spending journal, and track your purchases and receipts.
When you hold yourself accountable to your spending by recording and reviewing your expenses, you'll find that you become more thoughtful about how and where you're spending your money.
2. Create a debt reduction plan
Look at your income and your budget and determine how long it will take to pay off your debt, and in what order you plan to do so. Try to pay down the debts that have the highest interest rates first, while still paying more than the minimum payment on your other debts.
BECU members don't have to do this alone. Contact us today to make an appointment with a member consultant who can help you set a realistic debt-reduction plan.
3. Use cash whenever you can
When you buy an item on credit, you end up paying more for it. Every purchase you make on credit will impact your credit report. If you can pay with cash, then you should. A great tip? Create savings accounts to help fund what you normally charge, e.g., home improvement fund, travel fund – even a clothing fund!
4. Pay more than the minimum amount
If you only pay the minimum amount on your credit card or loans, you'll be in debt and ultimately spend more money on interest for the items you've purchased. Try to pay off the total amount owed on all your credit cards each month, and if that's not possible, put as much as you can toward your debt.
5. Be patient
Becoming financially healthy doesn't happen overnight. It takes time to learn the skills and accumulate the knowledge that's needed to make sound financial decisions and break old habits.
We're honored to be your partner on this journey! BECU members have access to informative seminars like our upcoming Reducing Debt & Building Credit Seminar, which will help you learn how to prioritize your debts, establish payment plans, identify spending issues and lay the foundation to change your financial behavior so that you're in a good financial position when it comes time buy a home.