Long before you start shopping for the perfect home, you have some homework to do. That homework involves repairing your credit. You might think that your credit is just fine or that you will find a lender that will give you a loan, but why take a chance?
There are many reasons you should start working on your credit long before you apply for a loan. If you aren’t convinced, consider the following reasons.
You Might Delay Your Closing
Unless you have perfect credit, there could be issues on your credit report that lenders require you to fix. They usually require proof of the resolution before they will allow you to close on the loan. What if there is an issue and you can’t get it done before the closing? Now you run the risk of violating the terms of your purchase contract because you didn’t close by the intended date.
Delaying your closing might cost you money in penalties. It might even cost you the home. It depends on the seriousness of the credit issues and the time it will take. You never know when a seller might pull the contract and put the home back on the market. Is it worth a chance?
You May Get a Higher Interest Rate
Lenders base your interest rate on many factors, with your credit score being one of the largest factors. A high credit score indicates to lenders that you are a good credit risk. It’s a sign that you pay your bills on time and you don’t overextend yourself financially. This makes you look good in a lender’s eye.
If you have a low credit score, lenders may look at you as risky. They will likely take a closer look at your credit history to see why you have a bad credit score. Do you pay bills late? Do you have high utilization rates? Do you have too many outstanding credit card balances? The lender will take all of this into consideration and come up with your interest rate. The more factors you have counting against you, the more likely it is that you’ll have a higher interest rate.
You May Pay More Closing Costs
Again, closing costs are determined based on your qualifying factors. The worse your credit is, the more closing costs a lender may charge. We aren’t talking things like underwriting fees or closing fees. Instead, we are talking about origination fees or discount points. Each point is 1% of the loan amount. On a $200,000 loan, each point is worth $2,000. You can see how multiple points can add up quickly.
Typically, lenders charge more points for risky borrowers. In other words, borrowers with low credit scores, high debt ratios, and low down payments pay the most fees. Obviously, the worst situation is to have all three of those risk factors. If you have compensating factors for a low credit score, though, you may be able to offset some of the fees.
You May not Get a Loan
Let’s look at the even larger issue at hand here – you may not get a loan at all! Your credit score is one of the first things lenders look at when determining your ability to secure a loan. If you have a bad credit score, it’s like giving the lender a bad first impression of you.
Each loan program has its own credit score requirements. A conventional loan usually has the highest requirements. Lenders like to see credit scores around 680 – 700 for these loans. FHA loans have the lowest credit score requirements, with a minimum score of 580 usually required. VA and USDA loan requirements usually fall somewhere in the middle. The VA prefers credit scores around 620 and the USDA prefers credit scores around 640.
Even if you meet the mortgage program’s minimum credit score guidelines, a lender still doesn’t have to approve your loan. Some lenders prefer higher scores to ensure that you are a good risk. Of course, you can shop around to find a willing lender, but it will take more work on your part than it would if you had good credit from the start.
We recommend that you start working on your credit as much as two years before you apply for a mortgage loan. This gives you ample time to figure out where you stand with your credit and determine what you should do. The more time you allow yourself, the greater the chances of your credit score increasing enough in time to get you a good loan approval.