Credit advice in preparation for buying a house a year from now?
I plan on buying a home about a year from now.
I’m 25, have never owned a home before, but I have a credit score that hovers around 780, so I’ve got that going for me. However, I do not plan on co-signing and my credit history will be 5 years long (and a few months) when I plan to buy.
Some friends of mine recently attempted to get a mortgage to buy a house, but were denied. I ask this question because my friend says they were told they’d have been approved if “I had a third line of credit at least a year old.”
I have two open credit cards (which I pay off) and an auto loan, which make up my credit history. Is there anything significant about the number 3 such that I should be looking into a third credit card? Especially since I’m purchasing alone? Is it more about the total amount of credit available to me?
With a 780 credit score you only need to worry about two things: income and down payment. Its likely that your friends had credit trouble.
If I were you I would pay off the car loan, save an emergency fund, and then save a down payment. That is a lot, can you do that in a year? How much can you have for a down payment by then?
Provided that you do not attempt to buy too much house, then you will be easily approved even if your score drops in the 730 range, and it will likely increase once you pay off your car.
This is called a “Tradeline Overlay”. There are a normal set of rules that must be met for approval of all mortgages such as minimum credit score (typically 560-620 ish) and debt to income ratio (for example 45% or lower). Some lenders add an additional requirement on top of the normal rules (called an “overlay”), and one of the popular overlays is a minimum number of lines of credit (called “tradelines”). Apparently the lender your friend is working with has a minimum of 3 tradelines as an overlay. Your friend should just shop around and find a lender that doesn’t have the overlay requirement (which I would guess the majority of lenders do not).
In my opinion you don’t need to do much if anything differently. Keep on top of your payments and your credit score will improve over time (but is already quite good). If your cards have relatively low limits and are therefore frequently utilized highly, then it could be worth asking for increased limits to help keep your utilization down. Beyond that I wouldn’t open new accounts or worry too much about your score, just keep doing what you’re doing.
The primary other factors in getting approved for a mortgage are income and debt-load. Your post home purchase debt to income ratio will have to be under a certain percentage (maximums vary by lender/loan type) but the lower the better. For many lenders this means credit card + car loan + mortgage payment should be no more than about 1/3 of your gross monthly income. When the time comes to purchase you can start making additional mid-cycle credit card payments if needed to drive down your debt to income ratio (captured in a snapshot when they run your credit report), but hopefully you aren’t extending yourself far enough where that’s an issue.
If you can pay off your car loan and save up a 20% down payment, that’d be ideal, but if you have a low interest rate car loan I would prioritize a 20% down payment to avoid PMI.
Your credit score is only one of many factors that go into a mortgage underwriters decision on whether or not to lend you money for purchasing a property. The score is used to give them a rough idea of how well you have serviced your previous and ongoing debts. A high score indicates that you are dependable in terms of making your repayments on time and for at least the minimum amounts expected by the creditor each week/month/year/whatever.
What a credit score does not tell them about a potential customer is how much debt they are currently carrying (their credit report will disclose this) and their ability to take on further liabilities.
It is possible to have a great credit score but already be teetering on the (theoretical) threshold of what you are able to repay each month based on your current income. Alternatively, you may have plenty of income and ability to repay debt, but have a terrible credit score because of poor debt management skills – making payments late or for the wrong amount.
There aren’t really very many types of credit. If you already have an installment loan and credit cards then I doubt this would be used as a reason to decline a mortgage application. The most likely reason an underwriter would decline an application is if the applicants debt-to-income ratio is considered too risky for their portfolio. Different lenders are willing to take on different amounts of risk (while not a universal rule, the interest rates they charge typically reflect their risk tolerance – a lender with higher interest rates can take on riskier customers, using the extra revenue produced from higher interest rates to offset losses incurred when a higher proportion of of their portfolio defaults on payments).
All lenders will consider your total current debt, plus the amount you’re asking to borrow, then compare that against your income (and to some extent your liquid assets). If you currently make $4,000 a month, have $600 in monthly loan and credit card repayments, and are asking for a mortgage that would require a $1200 monthly payment, then your debt-to-income ratio is (600 + 1200) / (4,000) = 45%. Some underwriters might be ok with this and approve the loan, others might want to see a lower percentage, say 43% or less.
In my 2016 first-time buying experience:
Credit score only affected the interest rate but me and my co-signer (brother) were both north of 700.
Max Loan amount was determined by how much me and my co-signer (brother) made in the last two years minus re-occuring monthly bills (like car payment).
Credit report was clean except for a single negative item (a phone bill I had disputed).
I purchased my home with zero-down required (I put some down).
Earlier in the year I was declined from a different lender for a cheaper home. The only difference was the lender.
Another random note, my eventual lender could not approve me for a loan until I removed the dispute on my credit. Their exact words we’re “you cannot have a disputed credit item, negative is OK, but you have to cancel your dispute for us to approve the loan”.
You asked multiple questions in your question but the answers are really all the same.