On e of the most frequent questions that I receive is from young buyers who haven't established credit. Most people know you have to have what is considered "good" credit to buy a home, but many people don't know what "good" credit is.
When a credit report is generated, the lender is reviewing a snapshot of how you handle money you have borrowed,whether that is on credit cards, student loans, previous mortgages or installment loans such as vehicles, personal loans etc. Not only is your credit history being evaluated with regard to paying these debts on time, but also the quantity of open credit lines and how high your balances are in relationship to your credit limit is part of the picture.
Minimally speaking, lenders look for three credit lines that have been in use for twelve months. To achieve a maximum credit score, variety in credit types, and balances that are no higher than one third of credit limits is recommended.
Since the financial issues of 2008, many people don't care to have credit cards. I understand the concern, however for mortgage lending, not having credit cards is not considered a plus. Often I have potential clients call who tell me they are ready to buy a home-they have closed all their credit accounts. While being debt free is admirable, it is not a virtue if you want a mortgage. So for those who don't care to carry credit card balances let me suggest that you pay down your existing credit cards but don't close them. Good open credit works for you in a positive way. Closed accounts do not.
If you are just starting out and want to build a credit history let me make some suggestions:
1) If you don't have any credit cards I suggest you open some little ones at places you patronize such as a gas card, big box retail, or a department store. If you have no credit it is possible that these will not be easy to get. In that case if you can ask a family member to be a joint owner of the card the effect will be the same. Barring that, you may be able to open a secured card or obtain a secured loan from your bank. This involves putting up a sum of money -$500-$750- to secure the card or loan. This does involve advance planning in that you want to begin this process about a year prior to buying your home.
2) Student loans count towards your credit score. It is especially important that you pay student loans on time as they are federal debt. Failure to pay federal debt is devastating to credit scores. But, if you had a credit card in college as many students do, the addition of a student loan that is in repayment is a boost. It is much easier to get that third credit source.
3) Rent payments are a part of the credit picture but rent payments don't show up on your credit report so can't help your score.
I have seen credit reports with nothing on them and I have seen credit reports with nothing but negative credit on them. Credit reports that have many negative items such as collections, judgments and tax liens are difficult to rectify, Many of these negative items if unresolved, remain on the credit report for up to ten years and will continue to have a negative impact.
There are some lenders that make exceptions to the "3 credit line" rule which once again is why a mortgage broker may be more flexible than a bank.
As a rule of thumb the lowest credit score that qualifies for mortgage financing is 620. Ideally, credit scores are 640 or above (on a 350-850 range) as the interest rate will be better.
If you think your score isn't good for one reason or another, don't be afraid to have your mortgage broker check for you. I have spoken to many people who thought they must have terrible credit and their credit was fine. And I have had some who have thought their credit was terrible-and it was- or those who thought their credit was great and it wasn't. For some, credit must be like beauty, in the eye of the beholder.
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