How to Fix My Credit to Buy a House

How to Fix My Credit to Buy a House

Roughly 70% of people who buy a house use a mortgage to complete the transaction1. Unless you’re a cash buyer, you’ll need somewhere between a good credit score and an excellent one to get an affordable interest rate on your loan.

If your credit file isn’t as strong as you’d like yet, here’s how to fix your credit score to buy a house.

What Credit Score Do You Need to Buy a House?

Generally, you should shoot for a FICO score of at least 760 to get the best interest rates, but your mortgage should still be affordable if you’re sitting somewhere above 680.

While you might qualify for an FHA loan with a score as low as 580, your interest rate is going to suffer. You’ll usually be much better off in the long run if you wait until you have a higher credit score to reach out to a mortgage loan officer.

Take a look at the table below for a demonstration of the difference in interest costs at various credit score ranges:

Interest Costs and Credit Score Ranges

FICO Credit Score

Estimated Interest Rate

Total Interest Paid

760 – 850

2.699%

$137,988

700 – 759

2.921%

$150,744

680 – 699

3.098%

$161,060

660 – 679

3.312%

$173,706

640 – 659

3.742%

$199,675

620 – 639

4.288%

$233,700

The numbers above are based on the MyFICO loan savings calculator results for a $300,000, 30-year fixed mortgage. The interest rates are as of 10/1/2021.

As you can see, improving your credit by even a single level can lead to substantial savings. If you raised your score from the lowest to the highest range, you would save just under $100,000 in this example.

How to Improve Your Credit Score

Improving your credit score takes time and discipline, but it’s not rocket science, so don’t listen to anyone who tells you they’ll fix it if you pay them. Giving money to a credit repair company is a waste at best and an outright scam at worst.

If you want to fix your credit to buy a house, you can and should do it yourself. It’s actually a simple process, at least in theory. All you need to do is:

  • Check your credit score and credit report
  • Contest any errors that you find
  • Apply for appropriate credit-building accounts
  • Make your payments on time and in full indefinitely

While there’s more to consider when you put it into practice, every credit repair strategy ultimately boils down to those four steps. Now, let’s look at what you need to know to go about it in reality.

1. Dispute Any Errors That Might Be On Your Credit Report

Building credit is a lifelong journey, and the first part of any long journey is to figure out where you’re starting. In this context, that means checking your credit score and credit report.

Comb through your credit report for any false information. An error can be something as simple as a credit card balance you paid off that’s still showing up or something as sinister as an account that someone else opened in your name.

Whatever the mistakes are, fix any you find as soon as possible. You don’t want unnecessary negative entries to hold back your progress, and some of the more serious ones, like an unrecognized credit line, suggest identity theft.

The best way to check your credit score is through free sites like Credit Karma and Experian. You can get your credit reports from many of the same sites.

(At Digital Honey, we like Experian because they give you your FICO scores for free – not your “FAKO” scores.)

To dispute any errors you find, send a letter to the credit bureau whose report shows the incorrect information.

It can be helpful to send one to the lender who reported it as well. You can find templates for both types of letters on the Consumer Finance Protection Bureau’s (CFPB) website.

2. Get (Up To) Three Credit Cards

Credit cards are a classic tool for building credit safely and affordably. Many lenders offer cards specifically to people with bad scores and non-existent credit histories so they have a way to get the ball rolling.

A secured credit card is a great place to start, as long as you can afford to put down a security deposit. Secured cards use them as collateral, which is why the lenders who offer them feel comfortable lending to riskier borrowers.

There is a benefit to having more than one credit line. It helps the diversity of your credit mix, which is worth 10% of your FICO score.

While there’s no objectively correct amount of accounts, three is a good rule of thumb. FICO once reported that people with credit scores above 800 have an average of three open credit cards.

3. Get a Credit Builder Loan

In addition to increasing the number of accounts you have, diversifying your credit mix requires expanding it into revolving and installment debt accounts.

Revolving debt includes any line that you can draw on, pay off, and then reuse. Credit cards and lines of credit are the most common examples.

Installment debt generally refers to any account that pays you a lump sum that you pay back in periodic installments over an agreed-upon term. A student loan and a personal loan both fall into this category.

Once you have a credit card or two, you’ve satisfied the need for revolving credit, but you can make your credit mix stronger by taking on installment debt.

Of course, you don’t want to take on a loan to build credit if you can’t put the money to good use, but that’s where credit builder loans come in handy. They function like an inverted installment loan.

Instead of paying you a lump sum upfront, you pay monthly installments of principal and interest first. Once you’ve paid off the loan amount, or whenever you cancel the account, you’ll get your accumulated principal in cash.

That structure protects the creditor against the risk of a borrower defaulting so you can qualify for a credit builder loan even with bad credit.

4. Make Every Payment on Time

Your payment history is the most significant factor in your credit under the FICO model and accounts for 35% of your score. If you do nothing except make your payments on time and in full each month, your score will inevitably go up.

If you ever do miss a payment, don’t think that the damage is done and let things languish because you’re already late.

No matter how late you are, waiting another day will cause even more damage to your score. Being late 60 days is much worse than being late 30.

Fortunately, there’s no reason to miss a debt payment anymore, at least not because you forgot about it.

You can set up recurring automatic payments with your bank to prevent any accidents. If you’re worried about overdrafts, set it to your minimum monthly payment instead of your statement balance.

5. Keep a Check on Your Credit Utilization

The amount of outstanding debt you have is the second most significant credit factor for FICO. It’s worth another 30% of your score.

One of the most impactful metrics FICO uses to assess your performance in this area is your credit utilization ratio. It gauges the healthiness of your credit card debt by comparing it to your total available credit.

The ratio equals your revolving debt balances divided by your total revolving credit limit. For example, if your only credit card has a $1,000 limit and you owe $400, you have a utilization ratio of 40%.

In general, the lower your utilization, the better off your credit score will be. A common rule of thumb is that you should keep your ratio below 30% at the most to avoid significant damage to your score.

Keep in mind, though, that 30% is a maximum, not a recommendation. Your score will benefit the most if you can keep it between 1% and 10%. Try not to reduce your ratio to 0% consistently, as it might look to lenders like you’re not using the account.

Of course, that doesn’t mean you can only ever use 30% of your credit line. Just make sure you know exactly when your credit issuer reports your balances to its preferred credit reporting agency and pay your debts down before that date.

6. Try to Pay Down Any Outstanding Debt

If part of the reason for your low credit score is that you have a pile of outstanding debt, your next goal should be to start working that debt down to a manageable level. Put a budget in place and redirect your monthly cash surplus toward your debts.

The best way to work off your outstanding balances is to target the account with the highest interest rate first. That will save you the most money and get you out of debt as soon as possible.

However, some people prefer to target the account with the lowest balance first. Paying off a card or loan can be motivating if it makes you feel like you’re making more progress.

These two approaches are known as the debt avalanche and the debt snowball methods, respectively.

7. Don’t Close Any Lines of Credit

Once you’ve reduced the amount you owe on your credit accounts, try to leave them open if possible. Not only will that benefit your credit utilization ratio, but it can also prevent any unnecessary damage to the average age of your credit accounts.

The age of your credit accounts is a metric FICO considers when looking at the length of your credit history, which is worth 10% of your score.

They care about the average age of all your open accounts and the age of your oldest and newest ones. In each case, the older, the better.

8. Avoid Hard Credit Inquiries (No More Than Two Per Year)

Whenever you apply for a new credit account, your potential lender pulls your credit report and initiates a credit check. Each time they do this, they’ll add a hard inquiry to your credit report.

Unfortunately, every hard inquiry will cost you a few points off your credit rating. To make your mortgage lender as happy as possible, try to keep your inquiries out so that you never have more than two affecting your credit at a time.

They age off your report after two years, but they stop impacting your score after just one. That means you can safely add one inquiry to your credit report every six months, on average.

FAQs

What credit score do you need to buy a house?

To get the best interest rate on a conventional mortgage, you should aim for a minimum credit score of 760, though you can still get a decent interest rate if your score is above 680.

Can I buy a home if my credit is bad?

It is technically possible to qualify for a home loan with bad credit. For example, you may be able to get an FHA loan with a credit score as low as 580. However, your mortgage interest rate may be significantly higher than it would with a better score.

Can I buy a house with no money down?

Yes, you can buy a house with no money down. However, you’ll usually need to qualify for a government-backed loan to do it. You can get a USDA loan or a VA loan.
However, USDA loans are reserved for low-income households in rural areas, while VA loans are for military service members and their families.
There are some credit unions that have no money down loan options for first time home buyers. And sometimes there are local grants that will cover your down payment.

Resources
1. https://www.redfin.com/news/all-cash-home-purchases-2021/

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