When your clients are first-time homebuyers, it’s important that they understand how their credit scores will impact a lender’s decision to give them a mortgage. Here’s what they need to know about their current credit scores, as well as a step-by-step process to improve them if necessary.
The Basics of Credit Scores When Buying a Home
When it comes to first-time home buyers, their credit scores are among the most important qualifying factors for a mortgage.
Credit scores are based on information in credit reports, which are compiled by three credit reporting companies: Experian, Equifax and TransUnion. Your clients are entitled to one free report per year from each company.
The information in a credit report lists things like car loans, student loans and credit cards, as well as accounts that have gone into collections and even bankruptcies. It also shows hard inquiries, which indicate that a lender has viewed the report, usually prior to deciding whether or not to extend a line of credit or a loan.
All of this information results in a credit score, which shows lenders how much of a risk your clients are. A credit score of 620 is generally a minimum requirement for a mortgage, but as the Consumer Financial Protection Bureau explains, even a score in the mid-600s will result in fewer options and the highest rates. As a rule of thumb, the higher the score, the better.
How Home Buyers Can Improve Their Credit Scores
It might happen that, after reviewing their credit reports, your clients want to improve their credit scores before applying for a mortgage. Here are some important steps they can take:
Check credit reports for errors and inconsistencies. MyFICO advises that they should be alert to payments that are incorrectly listed as late and that the amounts owed on open accounts is accurate. They should also be on the lookout for inconsistencies such as accounts they didn’t open, since this could indicate they’ve become the victims of identity theft. If this is the case, they need to report it to the authorities and remedy the situation before applying for a mortgage.
- Pay off any debt. The less debt they have, the better their scores will be. If necessary, they should make a budget that enables them to pay off any debt until it’s at a more acceptable level.
- Pay any collections. While this won’t immediately remove the collection entry from the credit report, it will show that the account is no longer in default.
- Pay any late bills and stay current with new ones. This is critical. Late bills can easily go into collection — and collections stay on a credit report for seven years.
- Keep balances on credit cards low. The lower your clients’ credit card balance relative to their income, the better, as this will positively impact their debt ratio.
- Don’t open any new lines of credit. Again, this would impact their debt ratio.
The Extra Effort Is Worth the Investment
Ultimately, if your clients improve their credit score, it will provide them with more financing options and likely result in lower rates. So even if it takes them a while, in the long run, it will be well worth the investment of time and effort. Plus, with the lessons learned from taking control of their credit score, your clients will ultimately be more financially savvy and ready to assume the responsibility of a mortgage with greater awareness.