Top 5 Credit Mistakes I Made While Buying My First House
Your credit score is a massively important factor in the home buying process because it decides whether or not you qualify for a mortgage (as well as how good of a rate you can get).
If you're reading this I will assume that you are considering buying a house.
Or maybe you're already in escrow and want to make sure you don't mess up anything during the transaction. I was just in your shoes a year ago as I applied for my first mortgage. And I know the feeling when you get another email from your lender asking for some new document or some explanation about a credit issue.
It's in your best interest to go into the lending process with your best foot forward. Although you don't need perfect credit, the more prepared you are going into the process the easier it will be overall.
Here's a list of the top 5 things that affected my credit score that you can fix before your lender sees it.
1. Credit Card Balances
I used to think that since I paid my credit card balances in full every month my credit would show that.
So I was caught off guard when my lender came back to me and told me my credit was 40 points below what my own credit report claimed it to be.
I found 2 causes, one being a different FICO score version was used (more on that later) but the main culprit was the balance reported on each of my credit cards!
But I paid them in full every month?
The problem is credit card companies don't wait for you to make your payment, they report your balance every month and snapshot whatever it happens to be at that moment.
So despite paying them in full every month, a balance was still reported since credit card companies report your balance mid-cycle before your payment is due. I have a lot of credit cards so this had a bigger impact on my credit than I could have ever imagined.
If you're going to be getting your credit score checked within the next 2 months, make sure to figure out when your credit card company reports balances, and pay it down before then even if your monthly payment isn't due yet.
After that, I went a little overboard and checked all my credit card apps every morning to see if any balances were added, paying them off immediately if so.
You probably don't need to do that, but it is important that you figure out when they will report your balance to the credit reporting agencies.
2. Credit Account Closed
Closing credit accounts will hurt your score a lot because they impact almost every factor of your credit score.
In fact, this is why I'm actively trying to add more credit lines and get more credit cards at all times.
Unfortunately back when I was preparing for my first mortgage I ran into a big problem. An old Amazon credit card I got but never used was closed without my knowledge! It showed up on my credit report as a closed account and my score dropped as a result.
Closed accounts impact your credit utilization, credit age, and total account factors. Of the 6 factors that impact your credit score, a closed account negatively impacts half of them!
First, your credit score takes a hit because your total number of accounts decreases. The fewer accounts you have the less experienced you are at managing lots of credit, at least from any lender's perspective. So down goes your score.
Next, your total amount of credit available decreases since that credit card's credit limit is no longer available to you. Up goes the percentage of your credit utilization as we talked about above. As a result, down goes your credit score even further.
Lastly, this account was a few years old, and closing it lowered the average age of all of my credit cards since I have many newer cards. As a result, my credit age factor is negatively impacted, and down goes my credit score once again.
So you might not think closing an old account is dangerous, after all, don't a lot of financial advisers like Dave Ramsey recommend it?
The truth is, it can be devastating to your credit score if you don't understand how it impacts various factors.
3. Hard Inquiries
A hard inquiry occurs when a creditor pulls your credit to consider giving you a loan or new line of credit.
It's a sign of how much credit a person is attempting to add over a period of time. And from the lender's perspective, someone who slowly adds loans and credit to their name is less risky than a borrower who suddenly tries to get as much credit as possible. It's definitely a red flag that they are in trouble and might not repay their debt.
I like to pick up a new credit card or 2 every year, and they usually add a hard inquiry to my credit report.
These hard inquiries alone might not disqualify you from getting a mortgage but they certainly add up and will decrease your credit score.
The worst part about hard inquiries is that there's very little you can do to clean them up. They automatically go away after 2 years and generally over time impact your score less and less. But until that 2 years is up you are stuck with every hard pull you attempt.
Since hard inquiries sort of decay and have a smaller impact over time, it's best not to do anything that would trigger a hard inquiry when you are soon going to apply for a mortgage.
This means no applying for new credit cards, auto loans, or even credit card limit increases. (More on those next...)
4. Credit Line Increases
Credit utilization is one of the major factors that goes into your credit score.
If you are using a lot of the credit available to you, lenders will see that as a risk that you might not pay them back first before everyone else. This is measured by taking the amount of credit you are using and dividing it by the total amount of credit available to you to get a percentage known as your credit utilization.
It's really a calculation of
credit debt / total credit = utilization. So if you have $7500 of credit card debt and a $15K total limit, your credit utilization is 50%. (That's very high and will hurt your score.)
If this percentage is too high your credit score will take a hit.
One way to improve this number is to increase the total amount of credit available to you. For example, this could be getting an increase to your credit card limits or getting new credit cards. If you had increased your credit limits from $15K to $50K, that $7500 credit card debt results in only 15% of your credit limit being utilized. That leads to a BIG score improvement.
However, we know getting a new credit card will result in a hard inquiry and drop our score a bit. So what if we just request increases on all our credit cards? I wish it was that easy...
As I prepared to apply for my first mortgage, I was trying to do everything I could to optimize my score which included trying to boost my credit limit to improve my credit utilization. Little did I know that some credit card companies will do this for you with no problem at all. While others will perform a hard pull and add a hard inquiry!
I was blown away by my next credit report.
My credit score dropped because even though I got a $1K credit line increase. All because I also got another hard inquiry added to my report.
Don't do this. Don't try to maximize your factors by a few points at the risk of adding marks that don't go away for YEARS... It's not worth it.
5. Multiple Types of FICO Scores
My lender called after he ran my credit and he did NOT have good news.
"Hey Nick looks like your credit score's a little lower than anticipated. This is going to affect your rate..."
I was crushed.
But I was equally very confused and very surprised. When I last checked it myself my credit was very strong?
How could my credit score be so different when he ran it compared to what all of the reports I pulled myself claimed it to be? The biggest culprit was the fact that FICO credit scores versions exist and different pulls may use different versions, resulting in different scores!
I had no idea this was a thing.
One pull could claim your credit score was 740 while another says 695 due to a different version being used that has different weights on different factors.
In fact there are apparently 16 FICO score versions used for different purposes. Making predicting the credit score a specific creditor sees a little tricky.
Hopefully, the takeaway here is to not just sign in to Credit Karma and rely on the score they tell you. That's not the same FICO score version that a lender will use.
If you want to try and forecast what they will see, here's the list of scores usually relied on for mortgage lending:
- FICO® Score 2, or Experian/Fair Isaac Risk Model v2
- FICO® Score 5, or Equifax Beacon 5
- FICO® Score 4, or TransUnion FICO® Risk Score 04
Note, most lenders will get a report containing multiple of these scores and may base their lending decisions on different factors, such as middle score, average score, or even lowest score. There isn't necessarily a standard here.