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6 Steps to Build or Repair Your Credit Before Buying a Home

Follow these 6 steps to build or repair your credit before house hunting so you get approved for a mortgage that costs as little as possible.

By
Laura Adams, MBA
11-minute read
Episode #529

4. Cut your utilization ratio.

In addition to correcting errors and cleaning up delinquencies, use your credit report to manage another key ingredient in your credit scores: your utilization ratio. This is the percentage of available credit you’re currently using.

For example, if your credit card has $10,000 of available credit and you have a $5,000 balance, your utilization is 50%. The optimal credit utilization is about 20% or less. So, paying down the balance to $2,000 would result in a quick boost to your credit scores.

Don’t make the mistake of closing any credit accounts before getting a mortgage. While it might seem like having fewer accounts would make you appear more attractive to a lender, it can hurt you.

Don’t make the mistake of closing any credit accounts before getting a mortgage. While it might seem like having fewer accounts would make you appear more attractive to a lender, it can hurt you.

Canceling an account could significantly reduce your available credit, which would cause your credit utilization to skyrocket and your scores to go down. So, play it safe and wait until after you move into your new home to close unwanted accounts.

Likewise, having more available credit relative to your outstanding balances can reduce your utilization ratio and help your scores. However, in most cases requesting a higher credit limit comes with an inquiry on your credit, which causes a slight ding. But requesting more available credit might be a good strategy that outweighs the downside, if you’re struggling to bring down your balances and cut utilization on your own.

Also, having a mix of revolving accounts—like credit cards and lines of credit—and installment loans (such as auto, personal, or student loans) helps your credit. If you close all your credit cards, that could negatively affect your scores.

Plus, some lenders require you to have at least two or three credit accounts already open in your name. To have the best credit you need to have both installment and revolving accounts with positive payment history.

See also: How Many Credit Cards Should You Have for Good Credit?

5. Reduce your debt-to-income ratio.

Another approval factor that mortgage lenders use is called the debt-to-income ratio. It shows how your expenses stack up against how much you earn. It’s a good indicator of how comfortably you could take on additional debt.

One formula called the housing or front-end debt-to-income-ratio shows what percentage of your income would go toward your housing costs, such as a mortgage payment, property taxes, association dues, and homeowner’s insurance. Another is the total or back-end ratio, which shows what percentage of income would go toward all your debts.

For example, if all your monthly obligations total $25,000 per year and you earn an annual salary of $50,000, your back-end debt-to-income ratio is 50% ($25,000 / $50,000 = 0.5 = 50%), which is high.

Most home lenders like to see housing ratios below the range of 25% to 28%, and total debt ratios below 36% to 40%. If you exceed these limits, you may need to pay down debt balances to get approved.

So, crunch the numbers on your debt ratios and see if you can reduce them by paying down debt or consolidating it so you have lower monthly payments. Additionally, paying down your outstanding debt balances, boosts your credit.

See also: 5 Lesser-Known Reasons Why Your Credit Scores Drop

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About the Author

Laura Adams, MBA

Laura Adams received an MBA from the University of Florida. She's an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura's previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.