Finances are often the biggest reason someone cannot purchase a home. Being financial ready is the most important step in the home buying process. It's important that potential homebuyers take the time to learn about finances and how they can make or break a home sale. Here, you can learn more about credit and how it relates to homeownership, and the steps you should take to become financially ready to purchase a home.
Credit Scores and Homeownership
Credit scores represent the credit worthiness of an individual. They say how likely a borrower is to pay back a loan based on previous borrowing history. Credit scores range between 300 and 850, with higher scores equaling higher credit worthiness. Credit scores above 670 help obtain more desirable interest rates and loan terms. Credit scores are damaged by late or missed payments to lenders. It is much easier to secure a mortgage loan with a high credit score and a longer credit history.
Factors Affecting Credit Scores
- Payment History: Do you pay loan payments on time? Are you late on credit card payments? Consistency in payments help increase your credit score. Payment history is the most important factor influencing your credit score.
- How Much Money You Owe and to Whom: Your credit utilization ratio is how much debt you have relative to how much money you can borrow. For example, if you have a $5,000 credit card balance with a $10,000 credit limit, your credit utilization ratio is 50%. Financial experts recommend you keep it below 30% for better credit scoring. If you owe money on many accounts, that may suggest to lenders that you are close to overextending yourself and cannot afford another payment.
- Length of Credit History: The longer you have a credit account open, the better. The length of your credit history can show how reliable (or unreliable) of a borrower you may be.
- New Credit: Every time you open a new credit account, a hard inquiry will appear on your credit report. This lowers your score by a few points every time it occurs. If lenders see many new credit inquiries in a short time, they may consider you to be a high-risk consumer.
- Types of Credit Used: It’s desirable to have more than one type of credit line, such as a mix of credit cards and installment loans. Maintaining diverse credit accounts in a responsible fashion shows lenders you can handle a variety of financial obligations.
Improving Your Credit Score For a Mortgage
- Check For Errors in Your Credit Report: If you have been penalized for a late payment but have always paid on time, be sure to have that error fixed on your credit report.
- Pay Down Credit Card Bills: Having high credit card debt will continually penalize your credit if you are unable to pay it down. Avoid putting more charges on the card and work on paying the debt down.
- Avoid Charging Credit Cards to Their Limit: It’s commonly said that you should only charge 30% of the total credit line amount or less on your credit card, and pay that down before charging more.
- Wait 12 Months After a Credit Difficulty to Apply For a Mortgage: If you had a financial problem that negatively impacted your credit score, wait a year with no other credit difficulties before applying for a mortgage.
- Avoid Taking Out New Credit Lines: New credit is typically considered risky to lenders. If you’re in the process of home buying, avoid other big purchases like cars or boats. Taking out new credit lines also lowers the average length of your credit history.
- Shop For Mortgage Rates All at Once: Lenders will check your credit score and history to determine what interest rates you qualify for. These inquiries will show up on your credit report and may lower your score by up to five points. If you rate shop with many mortgage lenders in a short period of time, credit reporting companies will lump the inquiries into one hard inquiry on your account when you apply. So be sure to shop for loans all at once.
- Avoid Finance Companies: Avoid borrowing from predatory lenders. These types of companies typically have extremely high interest rates and loans that can be seemingly impossible to pay off. Predatory loans can severely hurt your credit and hinder your chances of getting out of debt.
Becoming Mortgage Ready
Being mortgage ready can jumpstart the process of buying a home. Having sufficient credit and savings is the most important part of purchasing a home. Use the steps below to begin getting financially ready for a home.
Check your credit score and take the above steps to improve it, if necessary.
- If your score is below 620, start looking at steps to improve. The higher the score, the more likely a lender will give you a mortgage, and the better interest rate and loan terms you’ll get.
Start saving.
- Having sufficient savings is crucial when buying a home. Down payments, closing costs, and maintenance and improvements can be costly. Develop a savings plan, and if you're a first-time homebuyer, be sure to look at the Alabama First-Time Homebuyer Savings Account.
Reduce your current debt.
- If you have high credit card debt, work on paying it down before approaching a lender. If you have high interest rate debt, pay it down because it limits how much home you can afford.
Talk to a lender.
- Reach out to lenders and learn what the typical mortgage rate is. Talk to the lender about down payments and what you can do to secure a mortgage when you feel that you're in a good financial position.
Seek down payment assistance.
- If needed, seek down payment assistance. There are federal and state programs that help buyers purchase a home by providing down payment assistance. Be sure to look at both Alabama Housing Finance Authority and U.S. Department of Housing and Urban Development’s websites for different programs.