How to Build Credit to Buy a Home — The Complete Guide

Certified Mortgage Advisor
NMLS 1701021
Published 
June 28, 2022

Building credit? Here's how!

Let's talk about how to build credit, to buy a house. I'm gonna show you the minimum credit requirements for each different kind of loan, and the five main components of a credit score. So you can build yours quicker and then a simulator to help you take out the guesswork of increasing your credit score.

Why increase your credit score?

First of all, let's talk about why. Why in the world would you want to increase your credit? First of all credit, unfortunately, is really mysterious. It's this number in all these different algorithms that create a score that a lender's going to use to see if we can get a loan or not.

Also things like our interest rate and the costs and how easy the process is. And so the higher our credit score is the easier it is to move through that process. And get home or more specifically get a loan.

Reason 1: Gets approved easier

So one of the main reasons why we wanna do this is we wanna get approved easier. No one wants to go through the home buy process and it is really frustrating and time-consuming and a lot of stress.

Winning a bid

So having a higher credit score, allows us to qualify for better loans that can help us win a bid when we're putting in an offer for a home. So for instance, if you have something like a conventional loan, that usually has a higher likelihood of getting accepted by a seller than something like an FHA loan.

So a lower credit score might not qualify for a conventional loan, meaning that you might need an FHA loan, which could be more difficult to get the home that you want.

Higher loan amounts

Also, you can get a higher loan amount with a higher credit score. The higher your credit score is the less risky you are in paying back that loan to the lender. So they're more willing to give you a higher loan amount. The higher your credit score is. And of course, that's if needed never just get a higher loan amount, just cuz you had a high credit score. And because you can only get a loan that is comfortable for you with a monthly payment. It fits in with your short and long-term goals as well.

Less hassle and paperwork

Also, when you're able to get approved for things like conventional loans, with a higher credit score, then there's less hassle, less paperwork, and less stress. If you have a lower credit score, then often more documents are required and can be a more stressful process to go through which nobody wants at all.

Reason 2: Better terms

So another reason why you want to build up your credit score is to get better terms.

Lower interest rate

Now, most people are familiar with getting a lower interest rate if you have a higher credit score. So for example, let's start running through a scenario here where let's say you had, we're comparing two options and I'm using the software that I made called the Loan Clarity Advisor that helps you compare different loans side by side.

Let's say we were looking at comparing a 720 credit score vs. a 680, 3% down on a conventional loan on a $400,000 home. So likely what we would get is a 5.625%. Rate on this 720 credit score loan. If we had just a 680, that could go up to a 6.25% interest rate. So if we take a look, even over a period of 10 years, having a 720 credit score will save us $24,000.

We can also look through even over five years, that would save us $12,000 just by having a credit score that is 40 points higher. So that's why it's so important that we work on figuring out what is the best credit score that we can get when we apply for a mortgage.

Lower PMI

Also, you can get lower mortgage insurance. So if you're on a conventional loan, conventional loans have PMI or Private Mortgage Insurance that you pay monthly. If you have less than 20% down. So the higher your credit score, you have the lower the PMI rate that you'll get.

Lower cost and fees

Also, you can expect lower costs and fees and you can shop this around with different lenders as well. All of these things. So the rate PMI cost and fees. When you talk with different lenders, you'll get to see different rates, mortgage, insurance, and fees, and you can find which one works best.

Again, I have the Loan Clarity Advisor, you can check that out. That can help you compare loan estimates side by side, or compare mortgage quotes side by side. So you can make the best decision moving forward.

Find My Way Home

And if you do want to talk with a lender who's helpful and who makes actually educational videos, just like I do. I've partnered with Find My Way Home, just click on the link to get connected with a helpful loan officer who can guide you through all of this.

Why do lenders care about your credit score?

They care about your credit score because. Unfortunately, this is one of the biggest factors in getting approved for a loan. I say it's unfortunate because it's just so simplistic. It is a little reductive about a person, boiling your entire payment history down into one number. But what it's doing is this one number is supposed to represent the likelihood that you're going to pay back a loan.

So you're gonna have three credit scores. You're gonna have Equifax, Experian, and TransUnion. And the lender is going to look at all three when they do a credit pull and they are going to take your middle score or your median score. So for instance, 621 is the lowest. So they'll throw that out. The highest is 648. They'll throw that out and they will use the 634.

As the score to get you approved for the loan and also to find what your rate is going to be your mortgage insurance and things like that. Now, often people are curious about which scoring model lenders use for Equifax it's FICO Score 5, for Experian, it's FICO Score 2, and for TransUnion, it's FICO Score 4.

So this 634. Is going to be the Risk Score used on the loan. And so this is going to be for the approval, the interest rate, and the PMI. So here are the minimums for different loans that have different credit scores, and the minimums that you need to have to get that loan.

Lenders use the lowest middle score

One quick note too is if you're applying together, lenders are going to use the lowest middle score. They're gonna find each of your middle scores. If you're applying with a spouse or somebody else. Fund both of your middle scores and then use the lowest one there.

Soft and hard pull

Now, another question that comes up with a lot of people is what's the difference between a soft pull and a hard pull, a soft pull does not affect your credit score. And it doesn't show up on your credit report. A hard pull does show up on your credit report and only impacts your score anywhere from zero to five points. And so what a hard pull does is it's what a mortgage lender is going to need to pull, to be able to actually get you an approval for a loan. If a lender does not give you a hard pull, if they only do a soft pull, you really can't rely on that approval that they give you as much as if they give you a hard pull.

I like to think of it as a hard pull that shows you the full detail of your credit score. The soft pull is almost as if you threw a blanket over the top of it, you can see the outline and the shape, but you can't really see the details. And a hard pull is needed to get approved for a loan. So don't be afraid of that. You do have a 45-day window to shop for loans and get multiple inquiries, which I will also cover.

Credit score minimums

So here are some credit score minimums for different loans. Let's start here at the bottom at 500. This is the lowest that I've seen be able to get approved with different lenders.

What you can get within a 500 credit score anywhere from a 500 to a 579 is an FHA loan. With 10% down, 10% is a minimum on an FHA loan with a 500 credit score. You can also get a USDA loan with manual underwriting, which not every lender does. And you can also get a VA loan as well. Now, what's really important here. Is that lender can set their own minimums. These are the minimums set by the guidelines.

Every lender can choose to say, we know the guideline says 500 is a minimum, but we want to artificially raise it to 640 or whatever they want to. So if you run into a lender that can't do this, you can talk with multiple different lenders to find somebody who can, this is just what the guidelines say.

So then we go up to 580. If you have a 580 and above, this is where FHA 3.5% down starts. So we can get an FHA loan with three and a half percent down so far. Right now, none of these are conventional loans. So these are where some of those offers could be a little bit difficult to get accepted.

Because sellers tend to prefer conventional. Loans, especially in a seller's market. When we get to a 620, this is the minimum for a conventional loan. It doesn't mean you're going to be approved automatically, but this is what the minimum is to be able to apply for a conventional loan. And also this is very common as a minimum for VA loans.

So the bare minimum is 500 on VA, but a lot of lenders won't do VA unless they have a 620 credit score. That's one of those overlays that we commonly see 640 is another common overlay. For most loans like FHA or VA. And then also it allows you to get an automated underwriting approval with USDA, which is basically a lot easier than a USDA manual loan.

So we can see here everything below 640 in my mind is really ideal for some credit work. I think above 640 it's always great to have a higher credit score, but I think 640 really. The target to get to anything beneath this. I think it's really beneficial to start looking into doing some credit work before you get under contract to buy a house.

Up here when we get to 680 rates start getting better at 680 and higher. And then also this is often where the minimum credit requirement is for Jumbo loans and then 740. A lot of people don't really recognize is actually the highest that's where the scale kind tops out. You're not gonna get any benefit by having a 780 versus a 740 and no other benefit than having an 800.

That's not gonna get you any like bonus points. Every lender that I've seen tops out at 740, you're not gonna get a better rate. You're not gonna get better. Mortgage insurance. 740 is the highest. Okay. So we don't need to be super overachieving. 740 is at top of the scale for these credit scores.

Five parts of a credit score

Now it's important to remember in here that. When we talk about these components when you see that there are different scores, there's like FICO, there's Vantage, and inside of those two, there are tons of different types of scoring models.

They're all looking at these five different parts in different ways. So they're giving each different scores different weights. One looks at credit card payments differently than the other one does. And so these are wow the credit scores work, but the scoring models can change your score based on these factors.

So the different bureaus and different models can give different scores through these different parts of a credit score. So I hope that makes sense. I know it can be a little confusing.

1. Payment history

So the first part is payment history. This accounts for 35% of your credit score. This is the biggest factor in your credit score.

Paying on time pays a lot!

So things to consider here are paying on time and setting up automatic payments, really missing a payment. Having a late payment will derail your credit score.

No late payments please

So it's important to keep that in mind that a late payment can stay on your credit report for seven years.

You can correct errors or dispute

So something that you can do here is correct errors or disputes.  And one of the best ways to do that is through the CFPB they have an article to help you with that or you can also check ScoreMaster.

ScoreMaster

ScoreMaster can help you explore some of these credit errors that you may have on your credit report and actually take action with them. And that's something that I actually did with a late payment that happened in 2016 and got that taken care of with ScoreMaster.

2. Amount owed

The second part of your credit score is the amount owed. So this is your credit utilization. It's often called this is 30% of your score. This is basically how much credit have you taken out? How much debt do you owe versus your credit limit? Very common for people that may be your credit card limit is 3000 and you have a thousand dollars on that. So you have a utilization of $1,000 on a $3,000 credit card. So same thing here.

Strategize settlements/ pay for deletions

We wanna make sure that we correct errors with things like collection accounts, but it's important. Don't just randomly pay off collection accounts because you really want to strategize the way that you look at settlements or pay for deletions with these collection accounts. And so you can do this through someone like a credit coach or the CFPB has tons of great articles online that can help guide you through some of this a little bit.

The main reason we don't wanna just randomly pay off collections is it actually can lower your credit score. We wanna explore if we're gonna pay off collections either. If they can delete the collection from our credit report, or if they'll work on a settlement where we can pay less than the amount owed or get on a payment plan or something like that.

Get a credit card or secured credit card

Also, something that you can do here is get a credit card or a secured credit card because if you increase the credit limit, That you have access to it lowers your utilization. You can have a really high credit score just by having a few credit cards. And obviously, we want to use these well. We wanna make sure that we keep our utilization low and there are a couple of rules I'll talk about here in a second.

Assign your credit card

But what I would usually recommend for people is if they have multiple credit cards select use for each one. So maybe you have grass and a gas credit card. You have a groceries credit card. You have an eating-out credit card and then pay those off in full every single month. You do not have to pay a dime and interest to have a good credit score. You do not have to keep a balance on it to have a good credit score.

So with your utilization, what's usually recommended is the ideal is to stay below 10% utilization. So if you have a credit card that has $3,000 as a limit, you wanna stay below $300 or 10% of that limit with each account that you have. So you wanna keep that below 10% if you're up really high, the goal is let's get to 50. Then after that let's get to 30 and then let's get down to 10 and below and keep it below 10% to help your score increase.

The more you hit those limits. So if we get under 50, our credit score is gonna increase. If we get under 30%, it's gonna increase even more. And we get under 10%, it's going to increase even more. So we wanna keep that utilization low. We can't keep maxing out credit cards or else our score is going to drop.

Credit length : Patience is key

The other part is credit length. And this one stops up a lot of first-time home buyers who just don't have a lot of credit history. This is gonna take up 15% of your credit score. So obviously the majority of your credit score comes from payment history and amount owed, but this takes up 15%. Here, patience is key.

Adding an authorized user

Something you can look at doing is adding an authorized user. For somebody who has a good credit history, getting added to one of their credit cards can help increase the average age of accounts that you have.

And often what can happen for people, especially new first-time home buyers or people who are new to credit is they'll try to get approved for a loan, but they don't have enough credit length. And so often what can happen is you may need something like an FHA loan, which is more forgiving on credit length than something like a conventional loan.

Conventional loans like to see more than two years of credit history or something like FHA is a little bit more forgiving, but this also is where people struggle to go from maybe the low seven hundred up to the mid to high seven hundred or eight hundred is it really just comes down to credit length.

It's really difficult for somebody who is younger to have a very high credit score, just because they may have, all their utilization correct. And their payment history is good, but they just haven't had their credit long enough to be able to have super high credit.

Don't close revolving accounts

So credit cards don't disclose credit cards. Your score will actually lower having those credit cards active, even if you don't use them is going to help increase or keep your score at where it's at. Because the minute that you close it, it reduces the average age of accounts in your credit. We absolutely do not want that. So if you need to put on a small balance on your credit card and then pay it off just to keep that card active, so they don't automatically close it for you.

Credit Mix

Then 10% makes up the credit mix. So what different types of credit are you using? Do you have an auto loan, a mortgage student loan, or a credit card? If you just have credit cards, it's not as beneficial as if you have a mix of different varieties of credit.

Revolving credit

So we can have things like revolving credit. This is something like a credit card or an installment. This would be something like a car loan revolving is where we can keep putting a balance on and paying it off balance on, pay it off. An installment is where we have one big balance and we pay it off over time, like a car loan.

No need to pay dime and interest for a good credit score

So again, you do not need to pay a dime and interest for a good credit score. There is this myth. And I used to believe this cause this is what I was told in the beginning was that you have to keep a balance on your credit cards to have them actually show up as active on your credit report.

And this is not true. Your statement balance is going to be reported to you every month, as long as there's a statement balance. Then you can pay off your credit card every single month. And then you don't pay any interest and it gets reported to your credit report and that's going to increase your credit score.

Credit reports do not factor in how much interest you paid. You do not have to pay any interest. On your credit cards to maintain a good credit score.

What else can we do with credit mix?

Something else that you can do with a credit mix is, for instance, I just bought a couch recently and they were like, Hey if you sign up on our payment plan we'll give you 10% off.

So my option was to pay in cash or get on their payment plan and get 10% off. And so I was like, okay, if I get on your payment plan, can I just pay it off on month one and still get the 10% discount? And there's no penalty? And they're like, yep, no penalty. So great.  everything. I paid like $7 in interest for that first month.

And but what that did is that also added another installment line to my credit report to help increase my credit score. And then the utilization was low because I paid it off that first month and got a 10% discount on it as well. So you could do things like that to help add extra credit lines. In your credit mix to help this part of your score here.

Get your rent counted

Another thing that's really huge is getting your rent counted. Talk to your landlord about if they have this available as an option. Usually, this is only available as an option with like larger companies who have rental properties. But there are a lot of services online that you can use to actually get your rent counted on your credit report.

Inquiries

Inquiries are the ones that people are most afraid of, and I think misunderstand a lot. Don't be afraid of mortgage inquiries. And inquiry only impacts your score of zero to five points if you're applying for credit. Do it all at once. Because you usually have a window of time applying for four different things like an auto loan or a credit card. You have a period of time where you can get multiple inquiries to shop around.

45-day period to get unlimited mortgage inquiries

So with a mortgage, you actually have 45 days. You can look this up on the CFPBs website. They're the regulatory body that oversees consumer financing. You have a 45-day period to get unlimited mortgage inquiries, and it will only count as one inquiry. It's not that each time you talk with a lender and get your credit pulled your credit score is going to go down.

That is not true. One inquiry over 45 days, you have unlimited. You can get unlimited inquiries and it will only count as one, one inquiry will only change your score from zero to five points. What often happens is you have some of these like free credit reporting companies and they will say you got your credit pulled the sky is falling. By the way, here are our lenders that you should use.

Avoid people who inject fear

They kind of use fear to show you where they want you to go. That's often what happens there really should not be a lot of fear around getting your credit pulled. If you're looking at getting the best terms and shopping for a mortgage.

No impact after a year

These fall off over time. So they're going to lose their impact for over a year. Again, the impact is extremely low.

WAIT

Please wait to buy your house and buy stuff after you close because, your lender is going to know, and they're going to. If you got new credit before you closed on your home. So for instance, you can't get under contract to close a home.

You're gonna close next week, but then you went. And you bought a car and then you put a ton of stuff on a credit card. Please do not do that. Just do it after you close on your home because your lender will have to count in the new payments that you have on those new debts. And it could change your credit score to the point that you may not be able to qualify for the same terms as before.

Now, something that I often see people talk about is they say, I went and I shopped for, or I went and I got a car. And then they ran a ton of inquiries for a bunch of different places. And my score tanked, it's not because of the inquiries. The reason the score dropped is that they bought a car. They lowered their average age of accounts and they increased their credit utilization. It wasn't the inquiry that changed their credit scores as much as the lower utilization because of the new car loan balance and the lower average age of accounts, because they just added a new credit account. That's the reason the score dropped.

Please shop for a mortgage

So just keep that in mind, please shop for a mortgage. You are supposed to shop for a mortgage. It'll help you save a lot more money if you shop for a mortgage, all right. Do not be afraid of inquiries and don't shop for a mortgage just because you're afraid of an inquiry. It will not impact your score that much.

This is all an educated guess

When we look at all these five components of a credit score, there are little things that we can do, and we can try our best to increase them. But it really all is a guess, one of the best ways to actually figure out how to raise your credit score in the shortest amount of time possible is using something like a credit simulator, and mortgage lenders often use credit simulators to help their clients walk through the process and figure out how much money do they need to raise their score by what amount of points and what amount of time.

ScoreMaster helped me

It's difficult to do that on your own. But I partner with a company called ScoreMaster. I use it to help boost my credit score and you can too. I have a link in the description. If you're interested in learning more about that, or you can watch my interview with Jimena from ScoreMaster.

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