How to improve your credit score
Even if your credit score isn’t great, you can always improve it. The process just takes time. The most important action you can take is to pay bills on time. Late payments may stay on your credit report for seven years. Focus on your active and open accounts, as an account in collection does not have much effect on your current credit score.
Another good rule of thumb: don't max out your available credit or eliminate a credit line. You want to preserve a little wiggle room on each of your credit cards or credit lines. Credit experts recommend that you use no more than 30% of your available credit on any one card.
If you have closed accounts, one of the best ways to re-establish credit is with a secured credit card, usually issued by a credit union or local bank. The institution will require you to maintain a set amount in an account to offset any activity on the new account.
Another strategy for how to increase your credit score is to apply for a new card with a co-signer. With a card like this, it’s even more important that you make payments on time. If you fall behind or miss a payment, your delinquency will negatively impact your co-signer’s credit.
Other factors lenders consider when approving you for a home loan
It's not just about understanding what credit score is needed to buy a house. Additional factors can determine whether you'll be approved for a mortgage, including your income and assets, as well as the loan-to-value ratio and your debt-to-income ratio.
Debt-to-income ratio:
Your DTI is the total amount of your monthly payment obligations divided by your total monthly income. To be approved for a loan, your DTI ratio needs to be 36% or less. If your DTI ratio is too high at the moment, you have two options: pay down debt or generate additional income.
Loan-to-value ratio:
The loan-to-value is the portion of the property's appraised value that isn't covered by your down payment. To determine your LTV ratio, divide the loan amount by the value of the home you plan to purchase, and multiply by 100 to get a percentage:
For a house appraised at $200,000 and a loan amount of $150,000, your LTV ratio is 75%: ($150,000/$200,000) x 100
Income and assets:
Most loan applications ask you about your income. Insufficient income is sometimes a justification for denying a loan application.
When documenting assets, remember to include:
- cash, savings or checking accounts
- cash equivalents like CDs
- physical assets like cars, property, boats, recreational vehicles, jewelry or art
- non-physical assets like 401(k)s, IRAs, stocks, bonds, annuities or ownership in a business
How your credit score will impact the interest rate of your home loan
The relationship is simple – the higher a credit risk you appear to be, the higher your loan’s interest rate will be. A low credit score signals higher risk and will translate to a higher interest rate. A higher credit score qualifies you for a lower interest rate.
How credit scores are calculated
FICO scores are calculated using many different pieces of credit data in your credit report. This data is grouped into five categories: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%), and credit mix (10%).
As you can see, your credit rating is central to how a lender determines if you qualify for a mortgage loan. If you can keep your financial habits healthy, live within a reasonable budget, and make your credit card payments on time, you’ll be in a good position to show you are financially responsible and a good risk for a mortgage.
As you start searching for a home, you’ll be ahead of the game if you understand what credit score is needed to buy a house and the types of loans available to you. This insight will help you decide if you can move forward with your house purchase or if a better strategy might be to work on raising your credit.