For many people, the thrilling journey to homeownership includes shopping for a new home, envisioning décor and dreaming about what life will look like when it’s finally time to move in.
But if you’re also planning to borrow money to make your purchase, you’re going to want to keep an eye on your credit score up to and through the closing because it can have an impact on the loan and interest rate you qualify for.
Here’s a list of credit do’s and don’ts to help protect your credit, your finances, and ensure that you get those keys to your new home.
The Fair Isaac Corporation, which is the company behind the FICO score, says 35% of your score is based upon your payment history. Lenders look at your history to essentially predict how likely you are to pay them back.
If you’re doing all the right things to ensure your loan closes successfully (there are two closings – the loan and the home), the last thing you want is to be surprised by any unfamiliar credit activity. The Federal Trade Commission says it’s important to watch your reports on a regular basis, and particularly before making a major purchase, like a house, because your credit report can determine if you’re going to get a loan or not.
You may also want to consider signing up for a credit monitoring service which could notify you of changes to your credit report or even if there is any unauthorized activity linked to your credit profile.
Closing a credit card could not only have an impact on your credit score, but it could also affect your credit utilization ratio (how much of your available revolving credit is being used). If your credit utilization ratio increases, your credit score may go down as a result.
There are two main reasons why you might want to think twice before opening a new credit account. First, when you go to open a new line of credit, a hard inquiry takes place, which is factored into your credit score. Because hard inquiries may have a negative impact on scores, applying for any new credit during the home-buying process should be avoided.
Second, according to myfico.com, new accounts will lower your average account age, which could negatively impact your FICO Score, regardless of your credit history.
In addition to avoiding new accounts, you should also avoid making large purchases on existing credit before you close on your home. This includes purchases for vehicles, furniture, vacations, and yes, even that large-screen TV that will fit perfectly over your new fireplace.
This is because when you run up your credit card balances, you risk increasing your debt-to-income ratio (DTI) which could hurt your credit score. Your DTI is your monthly debt payments divided by your gross monthly income and is a benchmark mortgage lenders use to determine how much you can afford to borrow for a home loan. If your DTI increases too much from additional monthly debt, this could result in problems for your mortgage approval.
The higher your score, the better interest rate you will likely receive from a lender.
When we looked at FICO’s site, which is updated daily, the calculations for a $216,000, 30-year, fixed-rate mortgage worked out as follows:
Rate with a 760-850 credit score: 3.67%
Rate with a 620-639 credit score: 5.26%
The difference: $2,436 a year.
This list can help you be better prepared to make it to the closing table with a loan that fits your needs. It takes a lot of dedication, along with research and careful credit management, to purchase a home. You should be proud of what you’ve accomplished to get here.