You’ve probably read a lot about dos and don’t when it comes to purchasing a house for the first time, but what I want to discuss in this article is related to credit. Specifically some of the credit mistakes I see people make when it comes to purchasing a home. The interesting thing is that some of these mistakes are due to mortgage lenders providing their clients with bad advice!
Here are the top five credit mistakes I personally see people make again and again when purchasing their first home.
1. Accepting Bad Terms Due to Poor Credit
Yes, it’s possible to purchase a home with bad credit, but that doesn’t mean it’s always a good idea. The reason for this is pretty simple: when you have less-than-good credit, you’re going to get bad loan terms. All this boils down to you having to pay much more to borrow money in order to purchase this home.
Rather than accepting bad terms because your credit is bad, I recommend improving your credit score prior to getting pre-approved for a loan. This will definitely add some additional time and work to the process, but it’s absolutely worth it.
Many times mortgage lenders will recommend this as well. The problem is that they don’t always give you very good advice when it comes to actually raising your credit score. Let’s get into that now.
2. Blanket Disputing Negative Items on Your Credit Report
One of the most common pieces of “advice” mortgage lenders give their clients is to blanket dispute all the negative items on their credit report —items such as late payments, collections, and charge offs. This is a bad idea and it rarely works.
When you dispute a negative entry on your credit report, you’re basically indicating to the credit bureaus that you believe the information provided about the account is false or inaccurate. Simply disputing everything negative on your credit report is not only dishonest, but it’s also pretty clear to the credit bureaus what’s going on.
I’m not saying you shouldn’t dispute inaccurate information on your credit report, but rather, avoid disputing everything without even looking at it. Instead, you should be using the techniques outlined in these posts for removing late payments, collections, and charge offs.
3. Failing to Improve Credit Utilization
Credit utilization is an important factor when it comes to how your credit score is calculated. It’s a good idea to have an understanding of what it means and how you can use it to maximize your credit score.
Credit utilization basically means your ratio of credit-to-debt. In only comes into play with revolving debt such as credit cards. To give you an example of how to calculate your credit utilization, let’s say you have three credit cards with a total credit limit of $10,000. Now let’s say if we add up all the card balances it equals $5,000. That means your total credit utilization is 50%. Easy.
When it comes to getting a mortgage, when your credit utilization is too high, it’s going to negatively affect your credit score. Ideally you should get your total credit utilization under 20%. The lower the better.
Another way credit utilization can potentially affect your ability to get a mortgage is its impact on your debt-to-income ratio. Mortgage lenders look very hard at how much monthly debt you have compared to your income. And it makes sense why they care. When you get a mortgage, you’re adding to your total debt, so it’s important to them that you have enough income to cover the additional payment.
4. Getting a Co-Signer
I’m very cautious when it comes advising somebody with bad credit to get a co-signer on a mortgage. This is especially true for first time home buyers. The problem with co-signers in general is that your behavior (or luck) could really hurt a close friend of family member financially. I’ve seen this ruin relationships for life.
When you have a co-signer on the loan, that co-signer is basically telling the lender that if you don’t pay, they will. And the lender takes them for their word. If you don’t pay, they’ll go after whoever co-signed on the loan. You need to ask yourself if you really want to put that pressure on somebody who is kind enough to trust in you.
Rather than a co-signer, consider waiting just a little longer, improving your credit, and getting the loan yourself. That way your not indebted to anybody (except the bank).
5. Allowing Your Credit Score to Decrease Before Closing
I recommend that you get pre-approved for a loan before you start looking at properties. The main reason for this is so you’ll know what you can likely afford and won’t fall in love with a house and then be disappointed when it turns out to be too expensive.
One thing you need to keep in mind, however, is that a pre-approval isn’t a guarantee. Before you close, the lender will pull your credit report again and if anything has negatively affected it since the pre-approval you could be in big trouble. When you have a pre-approval in hand, be very careful about running up any debt, getting any new loans, or missing any payments.