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Plan Well, Retire Well

Saving and investing your money
Sasha Learns  2

Sasha Learns: How to Buy a House - More on Credit


A few weeks ago, I wrote a post about "The Credit Question" for my series on How to Buy a House! This week our focus is more on credit utilization as well as ways to potentially fix your credit before you go down the path of becoming a homeowner.

Credit Utilization

This is a fancy word for understanding how much credit you're using as a percentage. The higher the percentage, the more credit you're using. It's easier to give you an example:

Let's say you have three credit cards:

Credit Card #1: Credit line - $10,000. Balance - $1,500

Credit Card #2: Credit line - $5,000. Balance - $2,400

Credit Card #3: Credit line - $8,000. Balance - $3,500

You'll first add together your credit line amount: ($10,000 + $5,000 + $8,000 = $23,000) and then add up your current balances ($1,500 + $2,400 +$3,500 = $7,400). Then you divide the current balance by the credit line amount to give you your credit utilization. $7,400/$23,000 = 32 percent. In this example, the borrower is using 32 percent of their credit line limits.

*Most lenders are looking for a credit utilization score of 35 percent or lower, especially when it comes to purchasing a house for the first time. Some key things to note are:

  • Moving balances around on cards will keep the utilization rate the same.
  • Closing a card once it's paid off will increase your utilization score. In the example from above if you closed the first credit card, you'd lose $10,000 on your credit line and only have $13,000 to work with instead of $23,000!
  • Opening a new credit card can potentially help your utilization, but in the short term could impact your credit (lowering your score and possibly jeopardizing your chance to buy a house!)

Knowing what your credit utilization percentage before you go see a lender is a good way to see if you'd get approved or not. If you're percentage is higher than 35 percent, they may consider you a riskier consumer and not want to work with you to get a mortgage.

Ways to Fix Your Credit:

Fixing your credit doesn't happen overnight. For some it may be a long road to fix past mistakes. These are only suggestions on things you could try to help you fix your credit:

  • Check for Errors – Make sure if you find an error to dispute it right away. There are even easy errors that can be fixed quickly without too much hassle.
  • Open a Checking Account – Lenders want to know how you'll be paying them, and from where.
  • Use a Credit Card Wisely and Pay it off Each Month – You can use a credit card to purchase one category of expenses like gas or going out to each, then pay off the balance in full every month.
  • Build Credit in Your Name – Sometimes we have a partner or spouse who has a lot of credit, while the other has very little or no credit. Mortgage lenders are going to be pulling BOTH of your reports and taking an average from both sets of credit scores. It's important for both people to have similar scores to get the best interest rate!
  • Open a Secured Credit Card – A secured credit card is an option for someone with little to no credit history. This card uses money as collateral in case you can't pay it back. Limits are lower, but it's a good way to start building credit.
  • PowerPay your Debt If you're someone who is struggling to fix your credit but you have a lot of cards with balances, it may be time to get some help. One website I really like is PowerPay because this handy tool can help you eliminate your debt by snowballing it. If your debt is severely impacting your life, you may need to reach out to the National Foundation for Credit Counseling.

Although this isn't an encompassing list, it may help you get started. Go and check your credit utilization and if you're having problems check out some of the fixes for your credit.

Until next time,

Sasha

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This post continues a series on Sasha's journey through the puzzling world of buying a house for the first time. You can find other posts in the series by clicking Home Ownership in the Category list on the right side of this page.



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