Less Isn’t More: Credit Enhancement and Mortgage Qualification
Buying your dream home has never been more affordable. Millions of Americans have taken advantage of historically low mortgage rates to buy a home over the past year. In spite of interest rates that make mortgages very attractive, some are still on the fence about buying a new home. Some people are assuming that they do not have a high enough credit score to qualify for a mortgage. The good news is that mortgage rates should remain low for the foreseeable future. This gives everyone with less than perfect credit a chance to pursue credit enhancement strategies and still take advantage of low mortgage rates. If you are in this group and need to enhance your credit score, do not fall into the trap of thinking that you should close accounts. When it comes to enhancing your credit score, less is not always more.
Understanding Credit Enhancement and Mortgage Qualification
If your credit score is less than perfect, you should not count yourself out of getting a mortgage before you have spoken to an independent mortgage broker. You should see if you qualify for a mortgage before you discount yourself. That’s because there are a lot of mortgage products available that can help you buy a home without having perfect credit. For instance, VA Loans help members of the armed services secure home loans at great rates regardless of poor credit. If you are looking to buy a home in a rural or suburban area, then you might qualify for an USDA Loan, which also does not require perfect credit. Also, first time home buyers can take advantage of FHA Loans with less than perfect credit. A professional independent mortgage broker will be able to walk you through all of your options no matter what your current credit score is.
However, these are all special programs and have specific qualifications. Not everyone will qualify for these mortgage programs. In this instance, you still might need to pursue credit enhancement before you qualify for a traditional mortgage product. Again, working with an independent mortgage broker will help you know what steps to take to enhance your credit.
Closing Accounts Does Not Help
When you are looking to enhance your credit, the urge can be to pay off your accounts and then close them. However, this will not necessarily help your credit score. The first part of the urge is correct -- paying off your accounts will help. The second part of the urge -- closing your accounts -- will not necessarily improve your credit score. In fact, it could lower your credit score.
There are a number of factors that go into your credit score. Some of them are more important than others. One of the biggest factors is your overall credit usage. Simply, this is how much credit you are using of your available credit. A good range for your credit usage should be less than 30% of your overall available credit. This means that if you add up all of your different credit accounts, your balances should be only 30% of how much you are allowed to charge. For even higher credit scores, you should aim to be under 10% of credit usage.
Paying off your accounts will help you decrease your credit usage, which can help enhance your credit score quickly and dramatically. However, closing an account once it is paid off can sometimes decrease your credit score. This is because you are decreasing the amount of available credit you have. By paying off an account, but keeping the line of credit open, you are decreasing the ratio of credit being used to credit available, thus lowering your credit usage. The big catch is that you cannot be tempted to use your newfound credit availability. Making charges on these accounts after you have paid them off will only increase your credit usage, which can negatively impact your credit score.
Opening New Lines of Credit Might Help Your Credit Score
It might seem counterintuitive for those who are trying to enhance their credit, but opening new lines of credit can improve your credit score. Many people are afraid to open new lines of credit because they fear that hard inquiries on their credit history will negatively impact their credit score. There is some truth to this. Having an excessive number of hard inquiries on your credit report can decrease your credit score. However, this is one of the least influential factors in determining your overall credit score. In some instances, the benefits of opening new lines of credit actually outweighs the hit that can happen from hard inquiries. There are a couple of ways in which the benefit of opening new credits can outweigh the harms.
First, new lines of credit can improve your credit usage. If you can qualify for new credit cards, then the available balance of those cards will decrease your overall credit usage. Again, this is assuming you do not start making charges on this new line of credit. Since credit usage is the most important factor in determining your credit score, this could outweigh the harm of hard inquiries.
Second, opening new lines of credit can help diversify your credit, depending on the type of line of credit you are opening. Lenders and the major credit bureaus use loan diversity to help determine your credit score. They like to see a mix of different types of credit. For instance, having home loans, car loans, student loans, and credit cards shows a good variety of credit types. This shows lenders that you can handle debts responsibly under a number of different structures. For this reason, paying off some types of credit might not improve your credit score in the way you think it would. Paying off your car early might feel really nice. However, it might not positively impact your credit score if it removes a type of structured line of credit.
Final Thoughts
Everyone’s credit situation is different. It is important to pursue a credit enhancement strategy that meets your exact financial situation. If your goal is to enhance your credit score to improve your chances of qualifying for a mortgage, then you should be strategic in the steps you take. Working with a professional independent mortgage broker can help you make the right choices to improve your chance at qualification.
This is why our ideal client at Peoples Choice Mortgage is not necessarily people who are ready to buy a home right now. Instead, we love working with people who are looking to buy a home in the near future. This gives us a great opportunity to analyze your current financial situation, including credit score, to put you in the best possible situation to buy your dream home. We work with thousands of lenders to offer our clients a variety of products that fit all types of credit scores and down payments. The bottom line is that if you have been thinking about taking advantage of today’s low mortgage rates, then contact us! Don’t assume that you don’t qualify for a mortgage or that you cannot take steps to possibly qualify in the future. Our goal is to set you up for success, not merely walk you through rejection.
