Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to [email protected].
Credit score questions are the most commonly asked. Here I answer a couple of the most frequently asked.
Question. John from Green River, WY writes: Brian, it’s been over 15 years since I’ve owned a home but I just came into some money for a down payment and want to buy. What credit score do I need to qualify for a mortgage?
Answer. Hi John, that might not seem like an open-ended question but it is? Theoretically, you don’t even need a credit score to qualify for a FHA loan. A statement by the FHA says, “The lack of a credit history, or the borrower’s decision to not use credit, may not be used as the basis for rejecting the loan application.” I’m using FHA guaranteed loans as an example because many first time buyers use these due to the low down payment required and the low credit score hurdle. But reality is that it’s very difficult to find a lender willing to accept an application without a credit score. Lenders are allowed to set their own minimums.
With FHA guaranteed loans your credit score can be very low but the lower the score, the less desirable loan terms you’ll qualify for. Most prominently, it affects the amount of down payment that you’ll need and the interest rate that you’ll pay. For 2019, the lowest score (if you have a credit score) that the FHA allows is 500. That’s a really low score. With a score between 500 and 579, you’ll need a 10% down payment along with meeting other requirements such as enough income to make the payments. Most lenders require a score pf 580 or higher. That enables a low down payment of 3.5%. Conventional loans and others have different requirements. For many other loans, expect a 600 - 630 minimum.
Question. Racheal from Boston, MA writes: Hello Brian, I’m looking to buy a bigger home in the next several months. When I bought my first home, my 605 credit score dictated a higher than preferred interest rate. I’ve been paying that for almost 12 years. This time I’d like to qualify for a better interest rate. Currently, my credit score is hovering around 670. What can I do to improve it before applying for a mortgage?
Answer. Racheal, that’s a very good idea since a lot of people live in their second home a long time, many even retire there. First, let’s take a quick look at what a better credit score can do for your interest rate and long term finances. Interest rates are constantly changing but today with a credit score of 670, you can expect an interest rate of almost 5.5%. If you improve your score to about 800, your interest rate would be about 4.2%. The higher interest rate would cost you additional $245 every month. Over the full 30 years, you would pay an extra $88,400 in interest. Clearly, you’ll be rewarded for a better credit score.
The major credit bureaus all use the FICO model to calculate credit scores. The FICO model has five major components that are weighted differently. “Weighted” means each component has a different amount of effect on the score. The components and weights are:
Your payment history is what counts the most. This includes many things such as late payments, defaulting on loans, and bankruptcy. You can’t change this much because it is history. One thing you can do is obtain your credit report and review it for accuracy. You want to challenge anything that you don’t think is accurate. It’s up to the original lender to document that it is accurate. If the lender can’t document it (often they can’t) the bad rating must be removed from your history. This will improve your score. Also, the weighting changes with time. Everything falls off your report after seven years but as time goes by, bad credit events count less and less. The one thing you can do going forward is not be late on any payments. One late payment can ding your credit score as much as 60 points.
The amount owed component is one that fools some people. These people think that if they have a high balance and make the payments on time it helps their credit history. It doesn’t. What the FICO model wants to see is a consumer borrowing a small portion of the available balance and staying current with the payments. That number tends to be about 30% of the available balance. If you have one high balance, you can help your score by paying it down. This can help more than paying a little extra on a bunch of accounts that already have low balances.
The length of credit history is another component that some people make a mistake with when trying to improve their credit score. The longer you’ve had a history of on- time payments to a particular account, the better for your score. Even if the balance was paid off years ago but you can still borrow against it (like a line of credit or old store account). Don’t close these accounts so that they no longer show on your report. Leave these open. This shows a good history of repaying loans.
New accounts is another that you want to be very careful with when you’re about to apply for a mortgage. Try not to open any new accounts for at least six months before applying for a mortgage and definitely not during the application process until the loan closes. That means not buying new furniture for the new house before you close on the house. Also, no new credit cards. These send up red flags that you might be living on credit to pay your monthly expenses. These are only a few things you can do to improve your credit score but can be the most effective to the average consumer and home buyer.
Please comment with their thoughts and experiences for improving credit scores. Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to [email protected].
Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for 12 years. He also draws upon 30 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest. With the Pacific Ocean a couple of miles in the opposite direction.