How to Prepare Your Credit for a Mortgage

Buying a new home is an exciting financial milestone. But before you start looking for the right place, you need to look at your credit. Getting your credit in the best shape possible will help you qualify for the loan you want and access lower interest rates, which can save you thousands of dollars in the long run.  

Start working on building your credit long before you ever set foot in a potential new home. Here’s how to prepare your credit for a mortgage.  

Check Your Credit Reports

More than one-third of credit reports contain inaccuracies that could be caused by human error or even fraud, so you need to check your credit reports to make sure they’re accurate. Even if you don’t find inaccuracies, reading your credit reports will help you identify problem areas to address before you start applying for home loans.  

Once you have copies of your credit reports, review them for inaccuracies in the following sections:  

• Identifying Information: Your name, past addresses, and other personally identifiable information (PII). ‍
• Accounts: All the credit accounts you have held in the last seven years. ‍
• Bankruptcies: Any bankruptcies that were discharged in the last seven or 10 years. ‍
• Inquiries: Hard inquiries resulting from credit applications and soft inquiries resulting from other types of credit checks.

Inaccurate information you identify can be disputed online, over the phone, or by mail with the credit bureau that is reporting the incorrect information. At a minimum, you will need to submit a dispute form or letter that includes the following information:

• Your name and how to contact you.
• The credit report number.
• The furnisher of the information you are disputing.
• Account numbers or other data that identifies the information in the dispute.
• Your explanation of why the information is inaccurate.
• An explanation of supporting documents you have included with your dispute.

After you submit your dispute, you will wait 30 to 45 days while the credit bureau investigates. If the credit bureau finds the information is inaccurate, it will be removed from your credit report. If that incorrect information was harming your credit score, you will see a boost to your credit. If the information is not harming your credit, it’s still a good idea to ensure everything in your credit report is accurate.  

Even if all the information in your credit report is accurate, reading it will still help you identify strategies you can employ to build your credit before you buy a home.  

Tips for Improving Your Credit Score

Building a better credit score will help you get approved for the loan you want and access better interest rates and terms. Here are some tips for the credit management process:

• Pay your bills on time. Making payments on time builds credit, but making late payments or going into delinquency can damage your score.  ‍
• Maintain a low credit utilization ratio. Keep low balances on your credit cards and other revolving credit accounts.  ‍
• Diversify credit types. Having a mix of installment credit (such as mortgages and auto loans) and revolving credit (such as credit cards) can help your credit score by showing that you can manage different types of credit.  ‍
• Keep accounts open. The older your accounts are, the better it generally is for your credit score. Don’t close old credit card accounts if you don’t need to.  ‍
• Limit credit applications. Too many applications for credit in a short time frame can lower your credit score (unless you’re rate-shopping for your mortgage).  

Reducing Debt-to-Income Ratio

When lenders consider your mortgage application, one important factor is your debt-to-income (DTI) ratio, which compares your monthly current income to the amount of debt you hold. This is important because it shows lenders how stretched your finances are before you add to your debt with a mortgage.  

Lenders will assume that applicants with high DTI ratios will have difficulty repaying their loans, while applicants with lower DTI ratios are less risky. The lower your DTI ratio, the better the odds for your mortgage application. According to Wells Fargo, a DTI ratio of 35% or below is favorable, and higher ratios may require additional eligibility criteria or limit your borrowing options.  

To find your DTI ratio, simply add together your monthly debt payments (rent, mortgage, credit cards, loans, etc.) and then divide that number by your gross monthly income. Monthly expenses like utilities, groceries, and gas usually do not count. Your gross monthly income is the amount you make before taxes and deductions are subtracted. The result is your DTI expressed as a percentage.  

There are two ways to improve your DTI ratio: reduce your debt or increase your income. Some ways to improve your DTI ratio include:  

• Using a budget and removing unnecessary bills.
• Aggressively paying down debts including auto loans, student loans, and credit cards.
• Consolidating high-interest debts and reducing interest rates by using debt consolidation loans or credit card balance transfers.
• Increasing your income by pursuing a raise at work or starting a side hustle.

Managing Credit Inquiries During the Mortgage Process

When you’re preparing to take out a mortgage, you don’t want to submit too many new credit applications. This can appear as a sign of financial distress to lenders and credit bureaus. But that doesn’t mean you can’t shop around for the best home loan that fits your needs.  

Before you start submitting mortgage applications, consider getting preapproved or prequalified with a lender:

• Prequalification involves submitting financial data including your debt, income, and assets to the lender so they can give you an estimate of the loan and interest rates you can qualify for. This process is fast and only takes a few days.  
• Preapproval requires completing an official mortgage application, submitting financial data, and the lender performing a credit check. This is a more involved process that will help give you a more accurate picture of the loan and interest rate you can qualify for, and is a more involved process.  

Once you have prequalification or preapproval, you can more easily identify homes that are within your price range and demonstrate your creditworthiness to real estate agents and sellers. When you’re ready to submit an offer, you don’t have to worry about shopping around: multiple credit checks performed within a 45-day time frame usually show up on your credit report as a single inquiry and won’t significantly impact your credit score.  

Multiple inquiries for different types of credit, on the other hand, can negatively impact your credit score. Hold off on applying for new credit cards, car loans, or personal loans when you’re getting ready to shop for a mortgage. Too many applications can lower your credit score and hinder your ability to get the best interest rate for your home.  

Additional Tips and Best Practices

Here are some other ways to work on building your credit for your mortgage:

• Continue to check your credit reports and monitor your credit scores over time as you work toward buying a home.  
• Seek professional assistance and services when needed, such as credit monitoring, debt coaching, and debt consolidation. Make sure to seek out reputable providers.  
• Build an emergency fund to maintain financial stability. This will help you appear more creditworthy in the eyes of lenders and help you afford a down payment or home expenses.  
• Stay informed about changes in credit reporting and mortgage lending practices. Make sure you understand what you’re getting into when buying a home.  

FAQs

What is considered a good credit score for a mortgage?  

The credit score ranges for FICO® Scores are as follows:

• Very poor credit: 300 – 579
• Fair credit: 580 – 669
• Good credit: 670 – 739
• Very good credit: 740 – 799
• Excellent credit: 800 – 850

Can I qualify for a mortgage with a low credit score?  

With government-backed loans like FHA loans, you can qualify for a mortgage with a lower credit score. However, working on DIY credit management can help you improve your credit score and qualify for better loans with lower interest rates.  

Can I get a mortgage if I have a bankruptcy or foreclosure in my credit history?  

Bankruptcies and foreclosures stay on your credit report for seven or 10 years, and they make it more difficult to get a mortgage. Many lenders have waiting periods before borrowers with foreclosures can secure a mortgage, from two or three years in special circumstances to seven years. You will generally need to wait at least a few years, which will give you the opportunity to work on DIY credit management and get your credit ready for a mortgage.  

Bottom Line

DIY credit management is an important project to undertake when you’re getting ready to buy a home. By ensuring your credit reports are accurate, working to improve your credit score, establishing a good DTI ratio, and managing your credit applications effectively, you can build better credit to buy the home you want.  

CreditBuilderIQ gives you regular copies of your credit reports and credit scores, helps you track your DIY credit management progress, and gives you exclusive credit education. Get started with CreditBuilderIQ today to help get your credit and finances in shape for the homebuying process.