How to Rebuild Your Credit Before Buying a Home

Let’s start with a harsh truth: Borrowers with low credit scores have a hard time qualifying for home loans these days. Lenders are turning them away in droves. That’s the reality of the current mortgage market. But don’t lose hope if you’re in this situation. There are certain steps you can take to boost your score and improve your chances of loan approval. This article explains how to rebuild your credit before buying a home.

How Credit Score Models Work, Briefly

Consumer credit scores are basically a risk-analysis tool. Mortgage lenders (and other creditors) use them to evaluate the level of risk a particular borrower brings to the table. Generally speaking, lenders and creditors charge higher interest rates for borrowers with bad credit, and lower rates for those with excellent credit.

If the score falls below a certain threshold, the borrower might be turned down entirely. In fact, this is one of the most common causes of loan denial in the current lending environment.

The chart below shows the five categories of information that are used to determine your score. You’ll notice the blue and maroon slices make up for 65% of your overall score. We will address both of these factors below.

Want to rebuild your credit so you can buy a house? If so, you’ll need to focus on the two biggest “slices” in this pie chart. Focus on your payment history and the amounts you owe. Here’s how to go about it…

How to Rebuild Your Credit Score Before Buying

Credit scoring systems are complicated. But the factors they use to determine a person’s score are fairly straightforward. Most scoring models use the borrower’s payment history and credit “utilization” ratio, as the most heavily weighted factors. So if you improve these two areas, you could rebuild your score before buying a house.

Here are the five steps we recommend to accomplish this goal:

1. Identify the Source of the Problem

Low credit scores are actually the byproduct or “symptom” of a broader financial problem. To correct the symptom, you must first determine what is causing it. Perhaps you’ve gotten behind on paying your bills. Maybe you have a bankruptcy or foreclosure in your past. These are scenarios where the core problem is fairly obvious. And in that case, you can move on to the next step in the path to better credit.

But sometimes the cause is less obvious. For example, a common (but often overlooked) cause is having high credit card balances. Most consumers don’t realize this can reduce their scores. It can. But in fact, the “utilization ratio” is one of the top two scoring factors.

Finding the cause will require some investigation on your part. But it’s a necessary first step if you want to rebuild your credit before buying a house.

2. Review Your Credit Report for Errors

In a perfect world, the three companies that maintain credit reports in the U.S. (Experian, Equifax and TransUnion) would be 100% accurate 100% of the time. But they are far from perfect. They make mistakes, and these mistakes could potentially lower your score going forward.

So the next step in the process is to order copies of your credit reports from each of the companies mentioned above. You can do this for free by visiting AnnualCreditReport.com, a website that is jointly owned by Equifax, TransUnion and Experian. Do this as soon as possible — it can take some time to get your reports corrected.

If you find an error, you can submit a request to have it corrected through the website of the company that produced the report. Visit their website and look for a link that says “disputes.” There are laws that require them to process disputes in a timely fashion.

Erroneous information can drag your credit score lower than it should be. That’s the last thing you want when trying to buy a home. So check your reports for accuracy. Dispute any errors you find. It could help you rebuild your score and qualify for a home loan at a lower interest rate. So it’s well worth the time and effort.

3. Consider Reducing Your Credit Card Balances

Paying down your card balances could also help you boost your score. This is especially true if you are using a high percentage of your available limit, or you have “maxed out” one or more cards. When you combine this strategy with item #4 below, you will be on the road to recovery in no time.

There are good and bad types of debt. A mortgage loan with a reasonable interest rate might be considered a good debt. It keeps a roof over your head and helps you build equity in a valuable asset. But those high-interest credit card balances don’t do you any good. So work out a budget that allows you to start paying them down. Depending on your situation, this could help you rebuild your score to buy a home.

You’ll have to pay more than the minimum amount due each month, and you may have to scale back on certain luxuries. But nobody ever said this process would be easy.

Note: If your card balances are fairly low in relation to your limits, you might be able to skip this step. In this scenario, the balances might not be hurting your score at all. They might actually be helping. So you need to examine your situation closely before moving forward.

4. Pay All Bills on Time

Missing bill payments is the most common cause of bad credit. Your payment history also has the biggest impact on your overall score. It accounts for 35% of your overall score, more than any other factor. (Refer back to the chart above.)

Think about it from a lender’s perspective. Why would they want to loan money to someone with a documented history of not paying things back? That’s right … they wouldn’t.

If you want to rebuild your credit score before buying a house, you need to pay all of your bills on time. There is no way around it.

If you are missing payments because you can’t afford to pay them, then you have a budgeting and debt problem. In this case, you should try to reduce your spending as much as possible, or perhaps consolidate your debt under a lower interest rate.

If you simply forget to pay your bills on occasion, you need to create a system that makes it easier for you. Instead of putting bills aside when you get them in the mail, handle them right away. Better yet, set up auto-pay so you don’t even have to think about making the payments on time.

5. Get Your Spending Under Control

When you spend more money than you earn, you acquire debt. Having too much debt can lower your credit score and make it harder to qualify for a mortgage loan or other forms of financing.

You can’t improve your financial situation until you get your spending under control. And in this context, “control” means having a clear picture of your monthly spending, your monthly income (after taxes), and how the two of them relate. Develop a budget so you can see where your money is going each month. Then look for items that can be eliminated or reduced.

Improving a credit score is all about discipline and awareness. You must have the discipline to make payments on time, reduce unnecessary spending, and in some cases pay down your credit card-related debt. It’s hard work. It requires sacrifices. But it can seriously improve your financial picture, and your chances of qualifying for a home loan.

Disclaimer: This article explains how to rebuild a credit score before buying a home. It is partly based on information provided by FICO, the company that created the FICO scoring model. Such information is deemed reliable but not guaranteed. Credit scoring models are incredibly complex. As a result, there is no way to accurately predict how any of these strategies will affect you. We make no claim or guarantee that following these steps will help you rebuild your score. No one can make such a prediction. Do not make any financial decisions based solely on the information presented above. Continue your research beyond our website.