You’ve decided you want to buy a house, and you’ve set a timeline to buy that house in a year. Perhaps you signed a one-year lease on your current rental, and you want this to be your last year of renting. But your credit rating isn’t that good. Maybe you were late on student loan payments, or let a credit card bill get out of hand. Or maybe you just don’t have credit, because you’ve had roommates, or relied on family to lend you money when you needed it. There are things you can do to ensure that you're building credit to buy a home, even when your rating is shaky.
Building Credit for a Home
You will need to devise a timeline for yourself. You have a year, not a month, so that’s good. You will need to have a FICO score, and that takes six months. A FICO score is that three-digit number lenders and credit card companies will give you so they can predict how likely you are to make your payments. That score will also determine the interest rate you’ll pay. The name FICO comes from Fair Isaac Corporation and is the most well-known credit score.
Several factors go into setting your FICO score. While the exact formula is proprietary, there are guidelines. Payment history and amount of debt relative to credit limits each take up about one-third of your score. The rest is a combination of the average age of your credit accounts, recent applications for credit and having multiple types of credit, like a credit card, and some type of loan payment, like a car loan.
Secured Credit Card
Getting a secured credit card is a path to getting an unsecured credit card. You put down a set amount of cash, say $500 or $1,000, and use it as a typical credit card. That means buying things, paying for them using the credit card and paying the bill on time. You can pay off the balance each month, or pay some of the bill along with interest. It’s best to keep your purchases low enough to pay the balance and not incur interest because that will cost you money. Get a card with no annual fee or a low annual fee, and be sure it reports to all three credit bureaus; Equifax, Experian and TransUnion. Some secured credit cards do not require a credit check to apply, so this is the route to go if you have bad credit or no bank account.
Get a Traditional Credit Card
If you have enough credit to get a traditional credit card, you should apply for one. Some lenders consider it the best way to build credit. Don’t think of it as a ticket to debt. Instead, look at it as a tool. Learn how to make just the purchases you can pay for each month. You can use your credit card at the supermarket, or the gas pump. To limit your spending, record each expenditure so you only spend what you can pay off. Use the credit card to pay any recurring bills, like your cable or phone bill. If you hope to buy a home in a year and manage to pay off a credit card every month for six months, that may be enough to establish the good credit you need.
Pay Your Bills on Time
Paying your bills before their due date is important when it comes to building good credit. That means your utilities, car registration fees, insurance and taxes. Set alerts, so no bill is paid late. Do this during your one-year window, and you’ll go a long way toward that mortgage approval.
Loans to Build Credit
There are loans out there specifically to help people build credit. You borrow money, but you don’t get it until you’ve repaid the loan. What you’re doing is forcing yourself to save money, while building credit at the same time. These loans are often available through credit unions and local banks
Credit for Rent
There are rent-reporting services which track the rent you’re paying, and put it on your credit record, helping you build a good credit history of on-time payments. This doesn’t always work, but in combination with the other methods, can be used to show banks you are not a credit risk.
Good Faith Efforts
Practice good spending habits. Use a credit card and don’t let your balance go over 30 percent of your credit limit. Always pay more than the payment indicated on your credit card bill; that figure is a minimum. If you can pay off the balance, you should. Don’t open too many accounts at once. Keep the accounts you have open for as long as you can. Moving your credit card debt from one credit card company to another just to get a lower interest rate, can hurt your credit rating. Don’t close paid off credit cards, however. These can actually help your credit rating. Check your credit reports annually, because mistakes can be made on your credit report. If there are inaccuracies, report them to the credit bureau and stay on top of it until the error is corrected. Look for websites that offer you a free credit score, which will help you monitor your future financial habits.
Don’t Buy a Car
If you want to qualify for a mortgage, and your credit is already a bit shaky, don’t buy a car. This is not the time to make big-ticket purchases or take that fancy vacation. Put those off if you want to buy a house. In this case, you have to decide what’s more important, a house for the long-term, a car or a two-week vacation.
Remove Collection Accounts
If you have collections on your credit report, but you’ve paid them off, that alone won’t remove them from your credit report. Get in touch with the creditor and see if you can pay a fee to have the collection removed. A collection is a big stain on your credit report, and removing paid-off collections can go a long way toward fixing credit to buy a house.
Get an FHA Loan
Federal Housing Administration loans offer an easier, and a sometimes quicker path to home ownership if you’re a first-time homebuyer. Late payments or collections will not automatically disqualify you from getting a loan if you show that you try to pay your debts. If you incurred some bad credit after losing a job, but are able to show your commitment to paying your debts and building your credit rating, you may be able to get an FHA loan.
A Good Credit Score
So what is a good credit score? Credit scores range from 300, which is poor, to 850, which is excellent. Anything above 700 is considered good. You need a score of 580 to get an FHA loan. The number 650 is probably the number you want to aim for. If your score is below 650, you may be able to get a conventional mortgage with a higher interest rate. So try to get your credit score to 650 to keep from paying thousands of extra dollars in interest over the life of the loan, and you'll be well on your way to credit repair for mortgage approval. Doing this within a year's time should not be a problem if you set a plan and stick to it.
Karen Gardner is a former feature editor and writer and is now a freelance writer. She looks forward to doing her family's taxes each year, and likes to write about home finances and money subjects for the rest of us.