Building strong credit matters, no matter what financial goals you’ve set for yourself, but it’s essential in order to apply for a mortgage loan. Your lender will look at a number of factors when reviewing your loan application, and your credit history is weighed heavily when it comes to gaining approval for a mortgage.
Your credit history can be summed up into a single number – your FICO® credit score. This score is used to determine your creditworthiness when it comes to applying for a credit card, buying a car and, of course, buying a home. This number is calculated based on five different factors:
- New credit accounts opened – 10%
- Healthy mix of credit (credit cards, loans, etc.) – 10%
- Length of credit history – 15%
- Debts owed – 30%
- Payment history – 35%
Though weighted differently, all of these factors matter when it comes to your credit score, so it’s important to build and maintain your credit history carefully and strategically.
Why Good Credit Matters
Buying a house isn’t just about picking out the perfect home – it’s about being financially prepared to take on one of the biggest investments you’ll make in your life. When you apply for a mortgage, your lender truly wants to ensure you’re ready to take on the financial responsibility of owning a home, which is why there’s such a big emphasis placed on your credit history and score. As you can imagine, the higher your credit score, the better your chances of being approved for a mortgage.
How To Establish Good Credit
Building good credit doesn’t happen overnight, but there are many ways you can strengthen your financial background over time. It’s never too early to start working on your credit – and the sooner you do, the better off you’ll be when it comes time to buy a home. Below, we’ll highlight seven methods for building a strong credit history.
1 – Check Your Credit
First things first, you should be aware of your current credit score and history. You can obtain a free credit report from each of the three reporting bureaus (Equifax, Experian, and TransUnion) annually by visiting annualcreditreport.com. Not only does this information let you know where you stand financially, but it can also highlight any errors listed on your report – which should always be fixed as soon as possible.
2 – Keep Your Oldest Line of Credit Open
When it comes to building credit, you have to start somewhere. No one is born with great credit – it must be established over time. That’s why it’s beneficial to get started early and to continue maintaining your very first line of credit even years down the road. For example, my credit history was established when I obtained a student loan to attend college. While I wouldn’t call a student loan ideal, it does provide young adults the opportunity to begin building strong credit at a young age. By establishing my credit early and paying bills in a timely manner, I was able to take out a mortgage on my first home at age 24.
3 – Maintain Low Credit Balances
While it’s good to have open lines of credit, you want to be mindful of the debt balance you’re carrying. If at all possible, it’s best to pay off your credit card balances in full each month. This will allow you to demonstrate that you utilize your credit lines responsibly while also maintaining a low debt-to-income ratio (DTI). Lenders review a potential homebuyer’s DTI when he or she applies for a mortgage and want to see that ratio at 43% or less. Maintaining a low credit card balance is also beneficial for boosting your credit score.
4 – Make Payments On Time
Being financially responsible is a significant part of your overall credit history and controls your ability to obtain new lines of credit, such as a home loan. It’s important to always pay your bills by the due date, whether it’s a car payment, mortgage, medical bill, or any other type of balance due. Late payments can put a serious dent in your credit score, so make sure you stay on top of all your bills in order to build strong credit.
5 – Pay More Than the Minimum
While you’re technically not required to pay more than the minimum due each month, making larger payments can emphasize your creditworthiness. It also means you’ll chip away at your debt balances more quickly and end up paying far less interest over time.
6 – Avoid Big Purchases When You Plan to Buy
If you’re getting ready to purchase a home, pay close attention to this. Even if you’ve worked hard to build stellar credit, making large credit purchases prior to and during the mortgage application process can hurt your chances of being approved.
Lenders don’t like to see unexpected changes to your financial history right before you close on a home loan, so it’s best to always put off big purchases until after buying your home – and when you feel financially comfortable affording the purchase.
7 – Build Your Credit From Scratch
If you’re at the beginning of your credit-building journey, don’t feel discouraged. Establishing credit doesn’t have to be daunting. In fact, there are some simple methods for getting started.
- Become an authorized user on someone’s credit card – If you have a family member willing to add you as a user, you’ll be able to build your credit when payments are made responsibly. Beware that if the family member doesn’t make payments on time, this could backfire by affecting your credit history negatively.
- Apply for a secured credit card – This type of credit card is backed by a savings account, in which you deposit money that the creditor holds as collateral to secure the card. Making purchases and paying the balance off will help you build your credit score, in much the same way as a true credit card.
- Take out a credit builder loan – This is a great way to establish credit – all that’s required is for you to “borrow” money, which is frozen into a savings account until you fully repay the loan. As your payments are made on time each month, your lender reports this information to the credit bureaus, which builds your credit history and increases your credit score.
Whether you’ve been building your credit history and you’d like to improve your score or you’re just getting started with establishing credit, following the simple tips above will put you on the fast track to a strong financial background. Your lender is also a great resource for helping you reach your financial goals, so don’t hesitate to reach out for advice.