As any real estate agent or seasoned homeowner will tell you, one of the most important prerequisites for financing a home purchase is strong credit. Along with a steady income and a manageable debt level, your credit plays a pivotal role in determining whether you can get a loan and what your interest rate will be.
But you have to do more than just check your credit score on an app. Months before you ultimately close on your first home, you need to see where your credit stands and practice financial discipline.
Here’s a look at some of the common credit-related mistakes first-time homebuyers make so you can do things differently.
Forgetting to Review Your Credit Report
If you’re reviewing your credit report for the first time when your mortgage lender shares it with you, you may be in for a surprise or two. You might get lucky and have a spotless report, but you could also be kicking yourself for neglecting to address debt issues you swept under the rug years earlier.
“Start by getting a free copy of your credit report and checking it for errors,” says Lucy Randall, director of strategy and operations at online mortgage lender Better. “Errors can take weeks or even months to resolve with credit bureaus, so the sooner you can report them, the better.”
Errors can include wrong identification or address information, closed accounts reported as open and accounts reported incorrectly as delinquent. You might also uncover fraud — like accounts that you never opened showing up on your report.
“All those things can have an impact on your credit score,” says Shardea Ages, partner and financial planner at Greenwood Wealth Management in Atlanta. “If you take those off, you could have a positive result.”
Your report will help explain why your score might be lower than you’d like — possibly because of missed payments, an unresolved debt or high balances on too many credit cards.
Fortunately, you can obtain your credit reports for all three credit reporting bureaus for free through annualcreditreport.com. Federal law allows you to get one report free from each bureau each year, and through April 2022, you can get free weekly online reports from each bureau.
[Read: Best Mortgage Lenders.]
Relying on the Wrong Credit Scores
You should check your credit score regularly, and there are plenty of places — whether through an app or your bank — where you can do it. But don’t be surprised if the score you see on your phone is different from the one your mortgage lender uses to determine whether you qualify for a loan and, if so, what your interest rate will be.
Mortgage lenders rely on older versions of the FICO credit scoring model — FICO 2, 4 or 5, depending on the credit bureau — than the ones you might get on a scoring site, such as the widely used FICO Score 8 or VantageScore 3.0. One major difference between older and newer versions is that the older versions might still deduct points because you had collection accounts, even if you paid them off. Newer versions often ignore those accounts once they are paid.
To see your scores on earlier FICO versions, you might need to pay a company — such as a credit bureau — for access or check with a lender (although a credit pull might slightly hurt your score). You can also look at the score you have from a free credit scoring service as a guide, knowing that the lender’s version might be lower. Finally, you can review your credit report to see if you have issues that would dock your score in earlier FICO versions.
Misunderstanding How Credit Scores Affect Interest Rates
FICO credit scores can range from 300 to 850. The lowest possible score you can have and still obtain a mortgage is at least 500 for a Federal Housing Administration loan. You’ll likely need a score of 620 or higher to get a conventional mortgage.
You might have a credit score that’s good enough to get a mortgage, but that’s only part of the story. A “good enough” score likely will cost you thousands of dollars over the life of the loan compared with a better score.
If your score is in the 600s, a lender will likely offer you an interest rate that is higher than if you had a very good (740 to 799) or exceptional (800+) score, which will make your loan more expensive. For example, a $250,000 loan at 4% will cost $179,674 in interest over 30 years, but you’d pay $13,072 more over that same time if your interest rate were just a quarter of a percentage point higher at 4.25%. This also means your monthly payment would be $36 higher.
“The higher your credit score, the better rates you’ll be able to get, which can lead to significant savings over the life of your mortgage,” Randall says. “Your credit score also affects your pricing for mortgage insurance, which is required if you make a down payment less than 20%.”
[Compare: Mortgage and Refinance Rates in Your Area.]
Locking in on Just One Lender
No one says you have to work with the first lender you contact — or the second or third. You want to make sure you’re getting the best deal — including the right loan and interest rate — as well as the kind of service you expect. Interest rates and loan terms can vary greatly between lenders, whether a bank, credit union or online lender.
“You do not have to feel beholden to any one lender,” Ages says. “You definitely want to shop around, try to find the best rate.”
Don’t be too concerned that your credit score will be damaged if more than one lender pulls your credit score — as long as all the credit checks are related to one loan search, such as for a mortgage, it all counts as one hard credit pull in a 45-day window, Ages says.
There are a variety of mortgage loans, and not every lender carries them all. Some, for example, might not carry government-backed loans, while others might specialize in them.
“Many minority first-time homebuyers are encouraged to consider FHA loans due to the lower down payment requirements and less stringent credit history,” Ages says. “But this may not be the best mortgage program for you and your financial situation. A conventional loan may be more suitable for you because you can afford to pay a bit more down and avoid (private mortgage insurance) for the life of the loan.”
Ignoring First-Time Homebuyer Programs
There are many programs that assist first-time homebuyers with down payments, including government loan programs, special loan programs from Fannie Mae and Freddie Mac, and state and federal grant programs. It’s worth your time to research ones that are a good fit for you.
“Ask your experienced lender and Realtor about first-time homebuyer programs that you may qualify for, but also make sure you understand your eligibility, financial situation and the implications of each loan type,” Ages says.
You could also check with local nonprofit organizations that provide advice on mortgage eligibility and might know about grant programs that could be ideal for your situation.
“The nonprofits are not incentivized to sell you anything. They are instead going to tell you the steps needed to maximize eligibility and often take you through steps that prepare you to buy in the future, in the event now is not an ideal time to begin the process,” Ages says. “Programs like Operation HOPE and NACA (Neighborhood Assistance Corporation of America), for example, are great programs for first-time homebuyers. They help with creditworthiness and financial management skills necessary to be a successful homeowner.”
[Read: A Checklist for First-Time Homebuyers]
Opening Credit During the Underwriting Process
When you’ve been preapproved for a loan, signed a purchase contract and are just weeks away from closing on a mortgage, you might start looking ahead to your move-in date. Maybe you open a credit card so you can buy furniture to decorate your new home, or even buy a bigger car for all those trips you plan to take to the hardware store.
It’s a bad idea, because your mortgage preapproval is contingent on maintaining the credit record and debt-to-income ratio you had when you applied. If you drastically change that by opening more credit accounts, your loan application could be in jeopardy.
For example, buying items for your home on credit could show up as a new installment payment, “and that will likely adversely impact your debt-to-income ratio,” Ages says. “That will prolong the process because ratios will have to be recalculated and it becomes a nightmare.”
Additionally, don’t close credit card accounts, because that could affect your credit score, too, specifically the “length of credit history” calculation.
The Right Time to Start Preparing Your Credit
A common thread with all of these tips is time. Make sure you give yourself enough of it so you can do a full review of your credit record and finances, pay down credit cards, research lenders and types of loans, and understand the first-time homebuyer programs that are available.
“For most of my clients, we start about a year out,” Ages says. “If you need more time and if you’re in a position where you might be a first-generation homeowner within your family and don’t know where to go or where to start, maybe it’s best to start two years earlier so you have that knowledge. For the average person, 12 months is good enough.”
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6 Credit Mistakes First-Time Homebuyers Make Before Buying a Home originally appeared on usnews.com
