6 Things to Know About Your Credit Before Buying a House
You have the down payment. You’re making enough money to easily afford a mortgage. Now all that’s left to do is find a house and get a loan, right? Not exactly. Now what’s left to do is ensure your credit and financial history doesn’t hurt you.
Credit card debt is the devil
“Credit card debt is the devil,” said Brian Davis, co-founder and lead real estate and financial blogger for SparkRental.com. A real estate I investor with 15 rental properties, and a weekly personal finance columnist for BiggerPockets, Davis believes in negotiating old debts, not paying them off.
“When you default on a debt and it goes to collection, the original lender sells the loan at a discount for a loss. The new debt holder only paid pennies on the dollar for it, and will almost always accept a lower payoff amount if you call them and make an offer. Just don’t tell them that your motivation is buying a house – they’ll know they have leverage over you then.”
Stop applying for new credit a year before you apply for financing.
Stop applying for credit and don’t charge anything you can’t pay off in full each month. Better yet, don’t charge anything at all unless you absolutely positively need it. Keep those policies in place until after you close on your home, says financial expert Casey Fleming, author of The Loan Guide: How to Get the Best Possible Mortgage.
Fleming’s article, how “Ruin Your Credit in One Hour” details how buyers can ruin their credit with an afternoon’s shopping.
“I’ve seen a 150-point drop in score in a month or less when someone runs up their credit balances and then applies for more credit. Even folks with good credit and a perfectly reasonable use for the debt (i.e. finishing up a remodel) can get slammed,” he said.
“The lesson is if you are considering buying a home, meet with your mortgage advisor months before you want to start shopping. Get a baseline, clean up any messes if you have any, and learn what you need to avoid.”
Give yourself time to improve your credit weaknesses.
“Take time to make your credit as strong as it can be. It may take six months to a year, but the time you invest in cleaning up loose ends can mean a better loan and better rates,” said Michael Schaffer, a broker associate with LIV Sotheby’s International Realty.
Look for places to improve or strengthen your credit. For instance, if you’ve been paying bills late, even if only by a day or two, stop. Bring everything current and keep things current. Having a pattern of paying bills on time is critical.
“You may have to adjust your timeline for buying a house according to when you can clean up your credit,” said Schaffer.
Make sure your entire financial life is healthy
Have you paid your income tax to date? Do you have any tax liens? Are you behind in alimony or child support? The time to check on your financial history is before applying for a mortgage.
“Tax liens should be paid as soon as possible. If they aren’t paid, they will remain on your report indefinitely and have a significant impact on your credit score. Even after paying the tax lien it may remain on your credit report for up to seven years. The good news is that it’s possible to get the credit bureau to remove the tax lien if you can show proof that it has been withdrawn by the IRS,” said Nadia Kourehdar, Managing Attorney for the Ark Law Group.
What’s your marital status? If you’re getting divorced, or are separated, lenders will often ask to see the separation decree, which may or may not affect your ability to get a loan.
“Divorce decrees typically divide up the debts between the two parties. Unfortunately, it is common for the party who is now solely responsible for making the debt payment to default due to their financial upheaval. What people often don’t realize is that if both parties originally signed a note for the debt, they will still both be responsible for the debt if it isn’t paid. The default will damage the credit of both parties, no matter what the divorce decree says,” said Kourehdar.
“If you are looking to buy a house, and previously went through a divorce where the assets and the responsibilities were split up, it is smart to review your credit report asap to make sure there aren’t any hidden surprises.”
“Preapproval and prequalification are often used interchangeably, and that really muddies the waters,” said Schaffer. “Some lenders will tell you that you prequalify for the loan based on the income and credit information you have provided, but that’s not good enough for most sellers or real estate agents today. With a real preapproval, the lender will verify your income documentation and not just check your credit scores,” he said. “Buyers often hesitate about talking to a mortgage company or lender until they find the house they want to make an offer on, but they’re actually better off getting that approval before they start house hunting.”
“Getting approved for a loan is best done while you’re looking so there are no delays while going to closing. Buyers do need to be honest with their lender and their realtor so no one’s time is wasted. In fact, many real estate agents won’t show a buyer property until they have been approved. You can always change lenders if you find a better rate or a better deal. You don’t have to be locked into that lender.”
Put together an experienced team.
“Credit is only one part of the picture. It is wise for a buyer to consider their full financial picture before looking for a home and especially before buying a home. It’s important to consult with their team of experts – real estate agent, lender, and CPA if the purchase will affect a business. If you aren’t already using a CPA you probably won’t need one for a house purchase, but you will need a real estate agent, lender, and attorney. If a buyer doesn’t have a team of experts, it’s generally as simple as asking any one of these professionals to help them find the others, but look for experience,” said Schaffer.
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