How important is your credit when it comes to getting approved for a mortgage? More important now than it has been in the last fifteen years. This according to a recent data analysis by economic policy group the Urban Institute, which found that an increasing share of home purchase loans are going to consumers with FICO® Scores greater than 750.
From the report:
“In 2001, 24 percent of purchase loans had FICO credit scores under 660, but that share dropped to 13 percent in 2012, and further to 10 percent in 2013. The share of loans with FICOs greater than 750 increased from 31 percent in 2001 to 45 percent in 2012 and 47 percent in 2013.”
They go on to estimate that between 2009 and 2013, tighter credit standards resulted in 4 million “missing mortgages”—denied home purchase loans that consumers could’ve been approved for under the more relaxed credit standards back in 2001.
Approval rates aren’t the only thing credit plays an important factor in. Qualifying for the lowest interest rates usually requires having high FICO Scores. On a $270,000, 30-year fixed-rate mortgage, you could pay an extra $12,183 over the life of the loan if your FICO Scores dropped from 760 to 740 (if they dropped all the way down to 630, you could pay a whopping $90,955 more).
Lenders will be looking at more than your credit when you apply for a mortgage, but having excellent credit goes a long way toward getting approved and getting a competitive interest rate. Unfortunately, there’s no FICO Score wizardry for magically boosting your credit scores. Responsibly managing your credit over time is the best way to build it.
There are, however, some common credit pitfalls you can avoid to make sure your FICO Scores are at their best when your lender evaluates your finances. Here are three credit mistakes you should avoid in the run-up to your mortgage application:
Mistake #1: Not checking your credit
Let’s start with the most obvious credit mistake you can make: not paying any attention to your credit at all. Your FICO® Scores are generated using information on your credit reports. That’s why it’s important to check your credit reports for any errors that could be hurting your scores. A 2013 FTC study found that “one in four consumers identified errors on their credit reports that might affect their credit scores.” It’s best to check your credit reports for accuracy months before you start house hunting in earnest—you want to have plenty of time to dispute any errors you spot and get them fixed.
It’s also a good idea to check your reports from each of the three major U.S. credit bureaus (Equifax, Experian, and TransUnion). Lenders are likely to check your scores and reports from all three bureaus when deciding whether to give you the best interest rates or approve you at all. Even if only one of your credit reports has inaccurate information, the impact of the error on your FICO Scores could be significant enough to affect the terms of your mortgage.
Mistake #2: Applying for new credit
Applying for a credit card here and there in the months leading up to your mortgage application probably seems fairly harmless—the two might even seem totally unrelated. But applying for new credit before you apply for a home loan could cause a slight dip to your FICO® Scores and keep you out of the running for the best rates. There are a couple of reasons why:
- New credit applications trigger “hard” inquiries. When you apply for credit or a loan, the lender, credit card issuer, etc., will pull your credit report and FICO® Scores from any or all three bureaus. This shows up as an inquiry on your credit report. A hard inquiry is an inquiry authorized by you when you apply for credit (compared to a soft inquiry, which is an inquiry triggered when you pull your own credit report or when your credit report is pulled without you authorizing it by applying for credit).
Hard inquiries typically ding your FICO Scores by only a few points, but if your scores are hovering around a lender’s “break point”—say you have FICO Scores just above 700, and a particular lender will bump your interest rate if it drops below that—then that’s a score hit you can’t afford to take. Inquiries stay on your credit reports for two years, but FICO Scores only consider inquiries from the past twelve months—avoiding new credit applications a full year before you apply for a mortgage might be the best option if you want to maximize your scores.
- New credit accounts will lower your average account age. Your FICO® Scores also consider the average age of your accounts. The longer you’ve had an account in good standing, the better. Of course, there’s a flip side to this. Let’s say you’ve had a credit card, paid as agreed, for five years. Opening a new credit card account will cut your average account age in half, which can lower your FICO Scores. New credit only makes up around 10% of your scores, but giving yourself the best chance at a mortgage approval with good rates requires optimizing every last bit of your credit profile.
Mistake #3: Over-utilizing the cards you already have
Lenders evaluating your mortgage application will be taking a close look at your debt-to-income ratio—the percentage of your gross monthly income that goes toward repaying debt. This, of course, includes outstanding credit card balances. Lenders will more closely scrutinize potential borrowers who are revolving a hefty monthly balance on their credit cards. And it’s unlikely they’ll offer heavily indebted borrowers the most competitive rates.
But there’s another reason why getting trigger-happy with credit card purchases is not such a great idea right before you apply for a mortgage. Credit utilization—how much of your available credit you’re using—is a big FICO® Score factor. If you’re over-utilizing credit accounts, you could be doing damage to your FICO Scores without even knowing it.
There isn’t one ideal utilization ratio to aim for, but generally, the lower your utilization ratio, the better. For instance, let’s say you have a $2,000 credit card balance. With a $10,000-limit credit card, you’re utilizing 20% of your available balance—your utilization is in good shape. But say you only have a $3,000 limit. Now you’re utilizing over 60% of your available credit, you’re closer to maxing out, and your FICO Scores are more likely to be negatively affected.
The good news is that credit utilization doesn’t have any “memory” when it comes to your FICO Scores. This means that the effects of over-utilization doesn’t have any direct long-term impact on your scores. As long as you continue to make on time payments every month, your FICO Scores won’t be affected by that one month when you were on the brink of maxing out your cards. Lowering your utilization ratio now will “erase” the history of your utilization in the past (once the credit card issuer reports the lower balance, that is).