What Home Buyers Need to Understand About Credit


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Written by Guest | September 18th, 2019
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Guest Post by Shannon McNay-Insler

The home-buying process has a way of making people nervous about their finances, especially their credit. What’s worse, it can take a long time and pre-approved mortgage offers can expire. Suddenly, the pressure is on to make sure your credit is in top shape for as long as possible.

But what if you have other financial needs to tend to at the same time? Are you stuck waiting until you close on a house, or can you apply for other credit in the middle of the process? To answer these questions, here’s what home buyers need to understand about credit.

Credit inquiries might not be as damaging as you think

There’s a lot of fear around the damage credit inquiries can do to credit scores — but it might not be as bad as you think. FICO® explains the impact of hard credit inquiries:

“In general, credit inquiries have a small impact on one’s FICO® scores. For most people, one additional credit inquiry will take less than five points off their FICO scores. For perspective, the full range for FICO scores is 300–850.”

The danger doesn’t come from applying for one new account; it can come if you apply for many. Five points won’t hurt much, but opening new credit cards every month can add up.

That said, if your credit is in need of work, it might help to think twice about applying for new credit during the mortgage process. According to Jeff Richardson, Vice President and Group Head of Marketing and Communications at VantageScore, “for those who don’t have scores well above 740, applying for new credit shortly before or during the mortgage finance process is risky.” He goes on to say that, “Opening a new account can cause your score to decline slightly, though it rebounds in about three months assuming good credit behaviors are reported.”

Ultimately, it’s important to understand what’s most impactful to your credit scores overall. Payment history and amounts owed (especially credit utilization) have a much larger impact on your credit scores. That means paying all your bills on time and lowering your debt (especially credit cards) can help improve your credit far more than worrying about a credit inquiry.

Not all credit inquiries are the same

Not only do credit inquiries take just a few points off your scores at a time, some inquiries don't have any effect at all. Hard credit inquiries, which occur when you submit a full application for new credit, impact your scores. Soft credit inquiries do not. Soft credit inquiries happen when you check your credit scores. Since they don't affect your credit, you can utilize them to your heart’s content.

Rate shopping also minimizes the effects of hard credit inquiries. You can signal that you’re rate shopping by applying for mortgage pre-approvals in a short timeframe (14 days being the best) and always applying for the same amount. That will indicate that you don't intend to take out every loan you apply for, but rather that you're seeking the best deal.

Richardson also comments on rate shopping, advising that “consumers should shop around for the best mortgage rates and terms. In order to do so, you have to authorize multiple lenders access to your credit score, but so long as that activity is done within two weeks, it only counts as one credit inquiry.”

The real danger with new credit is additional debt

As you think about whether a hard credit inquiry might hurt your scores, consider this: The inquiry likely won’t cause much damage, but taking on new debt could.

Lenders will look at your total debt, so taking on a new installment loan (such as an auto loan) right before a mortgage could give them pause. This, of course, will depend on how much this adds to other debt you’re carrying, but they’ll also look at your income compared to your debt.

Therefore, unless you really need that installment loan, it might be best to wait until after you’ve secured a mortgage.

There’s more to the mortgage process than credit scores

Finally, here’s something to set you at ease: Your credit isn’t the only thing lenders will look at in reviewing your applications.

In fact, lenders look at many other factors. These could include down payment, assets, employment, property type, and more. Although your credit will need to hit a certain baseline to get the best interest rates, it’s still one piece of a larger puzzle. Here are some other important factors in the mortgage underwriting process:

  • Debt-to-income ratio — Your debt-to-income ratio (DTI) won’t factor into your credit scores, but lenders will likely look at it. Fannie Mae sets their maximum DTI for manually underwritten loans at 36 percent, 45 percent if you meet their “credit score and reserve requirements.” The maximum DTI goes up to 50 percent for desktop underwritten loans. You can calculate your DTI by dividing your total monthly debt obligations by your total monthly pre-tax income.

  • Loan-to-ralue ratio — Lenders will also want to know your loan-to-value ratio (LTV), which is the amount you want to borrow compared to the value of the property. The higher the LTV, the riskier the loan might seem.

Staying focused during the home-buying process

There’s a lot to think about during the home-buying process, but there’s likely no need to suspend all financial activity until the deal is done. And remember that there’s a lot more to the home-buying process than credit. You can improve your eligibility for the best rates by keeping your DTI low, building a strong down payment, and gathering all the paperwork you’ll need to prove employment and assets. The more prepared you are, the better.

Shannon McNay Insler is a personal finance expert with Upturn Credit, who focuses on credit, debt, and the emotional side of money. Her work has been published in Business Insider, Huffington Post, Inc., Lifehacker and more.

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