March 15, 2018
If you are planning on buying a home in the next few months, I bet you are already spending plenty of time checking out online listings. Listen up: That’s not where all your attention should be. Right now, the most important planning step you can make is to check your FICO credit score and make sure your finances are in the best possible shape.
With a few months to go before you start your house hunt in earnest, you can make moves right now that will make you look your best when you apply for a mortgage. If you wait until just a few weeks before you plan on applying, there’s not a whole lot you can do to help you shine.
I am not just talking about simply qualifying for a mortgage. If you are thinking about buying, you obviously have a strong sense that you will be able to get a loan. But your goal should be to get the best possible loan. The better your financial profile is, the lower the interest rate you will be offered. Even a small interest rate difference can add up to tens of thousands of dollars in savings over the life of a loan.
Your Pre-House Buying Financial Check List.
• If Your FICO Score is Below 740, Work on Getting it Higher. One of the most important factors lenders consider is your credit score. FICO credit scores range between 300 and 850. If you have a FICO score of 740-760 or higher, lenders will be more eager to offer you the best deals. Many banks and credit card issuers now offer clients free monthly reviews of their FICO credit score, if you log in to your account. That’s a quick and easy way to get an instant snapshot of where you are at.
If your score is lower than 740, please focus on boosting it as much as possible over the next few months. Every 10 or 20 point increase can help your cause. A 700 score might earn you a better offer than a 680 score. A 720 score is better than 700. Even if you don’t get to 760, make it your goal to polish your FICO score as much as possible.
• Pay Down Your Credit Card Balances. Ideally, you pay every bill in full each month. But if you have any unpaid balances, now is the time to tackle them. One of the biggest factors in your FICO score is how much of your available credit you have used. For instance, if you have three cards with a total credit limit of $15,000 and you have $5,000 in unpaid balances, your debt-to-credit “utilization rate” is 33 percent. If you can get your unpaid balances down to $2,000 your utilization rate will be 13 percent. There is no magic level lenders want to see, but lower is better. A utilization rate below 20 percent is going to help you qualify for a better mortgage offer.
• Pay Down Other Debts. The less you owe on student loans and car loans, the higher your FICO score will be. Also, keep in mind that lenders will want to see that your monthly debt payments—including the mortgage you are applying for—will not be more than 36 percent or so of your monthly pre-tax income. If you have just a few months left on a car loan, consider paying it off ahead of applying for the mortgage. Even if you can’t get those debts paid off in full, reducing the balance will help you qualify for the best possible mortgage terms.
• Stop Buying Wants. Even if you pay off your credit card bills every month, I still want you to become a shopping miser for the next few months. A quirk of the credit scoring system is that your score will be based on the last update to your credit file. If it shows a balance—even if you intend to pay it off in full when the monthly bill is due—that will affect your credit utilization ratio. The best advice is to charge as little as possible in the months leading up to a home purchase.
• Have Cash in Reserve. Okay, I sure hope you have an eight month emergency fund. But if you don’t, listen up my friends: mortgage lenders will likely want to see that you have some cash savings. Though there is no hard-and-fast rule, lenders want to know that if you get laid off, or sick, you can cover the mortgage for at least a few months. They may be willing to consider your retirement assets when running this check, but I sure hope you don’t fall back on this. Cashing out your retirement funds early to cover your mortgage will satisfy your lender, but compromise your retirement. It is far smarter to spend a few months right now doing everything you can to build up cash reserves. That’s not just smart, it will also help you shine in the eyes of lenders when you are ready to apply for a mortgage.