How to Get Your Credit Ready for a Mortgage: 5 Tips to Help You Prepare

When you take out a mortgage, a financial institution agrees to lend you enough money to purchase a home. In exchange, you promise to make monthly payments until you’ve paid off the loan balance. Each payment includes principal and interest, which is the cost of borrowing money.

Before approving your mortgage application, a lender needs to know you have the ability to pay back the loan. One way lenders determine your eligibility is by checking your credit. If your credit isn’t where you need it to be, don’t panic. Follow the tips below to get your credit ready for a mortgage.

Why Your Credit Score Matters

Your credit score matters because it reflects your ability to manage your finances. When a lender reviews your mortgage application, they want to see that you pay your bills on time and follow through on your financial commitments. Applicants with high credit scores represent less of a risk to lenders, so they have better chances of approval than applicants with low scores.

Your credit score also makes a big difference when it comes to your mortgage interest rate. If you have a high score, you’re likely to pay your loan as agreed. As a result, you may qualify for a lower interest rate than someone with scores in the poor or fair ranges. 

If you borrow $300,000 at 5%, you’ll pay nearly $280,000 in interest over the life of a 30-year loan. This assumes that you don’t make extra principal payments or incur any additional fees. If you borrow $300,000 at 6%, you’ll pay more than $347,500 in interest over the same 30-year period. In this scenario, a slightly higher interest rate costs you nearly $70,000.

5 Ways to Get Your Credit Ready for a Mortgage

It’s best to hold off on applying for a mortgage if any of the following statements apply to your situation:

• You have no credit score because you’ve never taken out a loan or opened a credit card.
• You have very little credit history, such as a single credit card with a low limit.
• You’ve had a few financial setbacks, causing your credit score to drop significantly.

The good news is that you can overcome these roadblocks to buying a home. To get your credit ready for a mortgage, follow these tips.

1. Apply for a Credit Builder Loan

A credit builder loan is ideal if you have little to no credit history. This type of loan gives you access to a small amount of money with a short repayment period. You build credit by making on-time payments during the loan term.

Note that credit builder loans are a little different from personal loans. When you take out a personal loan, the lender deposits the money directly into your bank account. With a credit builder loan, the lender puts the money in a certificate of deposit or a secured savings account. Therefore, you can’t access the funds until you make your last payment.

2. Increase Your Credit Limits

Credit utilization is one of many factors used to calculate your credit scores. Although utilization sounds complicated, it’s just a term used to describe how much of your revolving credit limit you’re using.

Revolving credit is a type of open-ended debt. When you take out a personal loan, you receive a lump sum of money and pay it back in installments. The loan has a defined term, so it isn’t considered open-ended.

In contrast, credit cards qualify as revolving accounts because you can keep using them as long as you don’t hit your limit. Generally, lenders prefer to approve applicants with low utilization ratios. You can calculate your utilization ratio by dividing the sum of your revolving balances by the sum of your revolving limits.

For example, if you have revolving balances of $2,000 and credit limits totaling $10,000, you have a utilization ratio of 20%. Before you apply for a mortgage, it’s best to reduce your utilization as much as possible. One way to do that is by asking your credit card companies to raise your limits.

In the example above, your limits totaled $10,000. If your total credit limit increased to $20,000, your utilization ratio would drop to 10%.

3. Dispute Errors on Your Credit Reports

Around 20% of all Americans have at least one error on their credit reports. If your credit reports contain late payments, charge-offs and other negative items that aren’t yours, those inaccuracies could be dragging down your scores. 

Fortunately, it’s possible to dispute errors and have them removed from your credit reports. To challenge an inaccuracy, follow these steps:

1. Gather supporting documentation. For example, if your credit report says you missed a payment, get a copy of the canceled check or find the confirmation number you received when you made an online payment.
2. Write a dispute letter. Credit.com offers detailed instructions for writing dispute letters and mailing them to the credit bureaus. Your letter should describe the error and explain why you believe it’s incorrect.
3. Wait for a response. By law, credit bureaus have 30 days to investigate your dispute. Once they make a decision, they must notify you within 5 days.
4. Work with a credit repair agency if you aren’t sure how to handle a dispute or need help following the dispute process.

4. Make On-Time Payments

Your payment history accounts for a significant portion of your credit scores. In fact, a single late payment can cause your score to plummet, making it more difficult to qualify for a mortgage. If you don’t have a long history of on-time payments, now is the time to establish one.

To avoid late payments, set up autopay on your credit card and loan accounts. With autopay, your lender withdraws your minimum payment from your bank account each month. If you’re trying to pay off debt faster, you can always make a second manual payment later on.

5. Pay Down Debt

If you have a lot of debt, your preferred lender may wonder about your ability to make monthly mortgage payments. Additionally, an excessive amount of debt can cause your credit scores to decrease, making it tougher to get approved for a home loan.

To improve your score, pay down as much debt as you can before you apply for a mortgage. Some people prefer the avalanche method, while others prefer the snowball method. Each method has pros and cons.

The avalanche method involves paying off debts according to their interest rates. You pay off the debt with the highest interest rate first, then the debt with the next highest interest rate and so forth. For example, if you have a $1,400 debt at 28% interest and a $700 debt at 8% interest, you’d pay off the $1,400 debt first.

Paying off high-interest debt first reduces the amount of interest you pay over time. However, it’s tough to stay motivated when your high-interest debts have high balances.

The snowball method involves paying off your debts in order of smallest balance to largest balance. For example, you’d pay off a $300 debt before paying off a $650 debt. When you pay off one debt, you apply its minimum payment to your next debt, creating a “snowball” effect.

One of the biggest advantages of the snowball method is that it helps you stay motivated. Paying off one or two balances can give you a mental boost that makes it easier to tackle larger debts in the future. The biggest drawback is that you may end up paying extra interest because you pay off your debts according to their balances instead of their interest rates.

Next Steps

Most of these tips require several months to implement fully. However, it’s well worth the effort to boost your scores. Before you apply for a mortgage, get copies of your credit reports to avoid surprises when your lender does a credit check.

It’s also helpful to check your credit scores before you meet with a loan officer. Understanding your scores can help you determine the best way to get your credit ready for a mortgage. If you need just a few extra points, for example, you might focus on paying down debt and raising your credit limits.

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