First time homebuyer? Get your credit profile in order

Buying a home is an exciting venture, but as thrilling as it may be, as a first-time homebuyer you should take some crucial steps before and during the process if you plan to use a mortgage loan to purchase the home.

Before you embark on your journey, take a good look at your overall finances. Knowing where you stand now and what you need to do to improve your credit profile and your debt-to-income ratio will have a powerful effect on the size of loan for which you will qualify, the interest rate and total cost of your loan, and the size of the monthly payments you will be paying.

Review your credit report

Start analyzing your credit report before you start your home buying process. You can request your reports from the three credit bureaus – Experian, TransUnion and Equifax – free of charge at annualcreditreport.com. You’ll need to do this in advance in order to fix any errors on your report and improve your credit score.

It’s smart to review your entire credit history on the reports. You will be able to spot errors or flaws that you can correct, thus helping boost your credit score.

Although you can’t legally remove information from your credit report, you do have the right to request an investigation of information you believe is out of date, inaccurate or incomplete. If you see any information that looks unfamiliar or wrong, file a dispute by phone, online or by mail with the credit bureau that has the inaccurate information.

Make sure your name spelling, Social Security number and current and previous addresses are correct. This will diminish incorrect information from appearing in your report, which can confuse lenders. Seeing accounts from a bank, lender or store with which you have never done business could be due to a simple mix up. Of course, they can also be a red flag that you are the victim of identity theft or fraud, in which case you should take appropriate actions.

Late payments?

Make sure that all of the payment activity on your credit report is accurate. If you notice a missed or late payment notation when you are sure you have never paid late, report the error. After the bureau receives a dispute, it contacts the source that provided the data. They have 30 days to respond. If they cannot verify the data, the information must be removed from the report. You will be notified in writing of any actions that occur because of your dispute.

If you do have legitimate late payments, you can add a 100-word statement explaining the reason why. If they are a reflection of economic hardship that has since improved, for example, say that so lenders can see you’ve made progress. This statement will be attached to your credit report file.

Add missing accounts

Since creditors are required to supply information to only one of the three major credit bureaus, check to see which of your accounts show up on each credit report. For example, if your Experian and Equifax reports show a certain account you use or have used, but it does not appear on your TransUnion report, let TransUnion know because the lack of the credit account history can negatively affect your credit score.

Credit-use ratio

You should also try to get your credit card use ratio to 30 percent or lower. That means you are not using more than 30 percent of the available credit limit on each card. For example, let’s say your credit card has a $1,000 credit limit. You would want to maintain a balance of $300 or less. Otherwise, it can appear to lenders that you are overextending yourself.

Your credit score

Your FICO credit score summarizes your risk of default in a three digit score ranging from 300 to 850. There are multiple categories involved in comprising a credit score, some of which are type of credit in use; new credit established; length of credit history; total of balances; and payment history.

Should you close an unused account in order to improve your credit score? Not necessarily. Closing unused credit accounts that show zero balances and are in good standing will not raise your FICO score. In fact, it may decrease your credit score – particularly if it was a long-standing account with non-delinquent payment history.

The good thing about the FICO score is that bad credit performance on old accounts weighs less heavily on your credit score. So, if you’ve been doing well recently, lenders will see that as a positive and your credit score will generally reflect the positive activity.

Income and employment

Mortgage lenders look at a whole array of data when considering whether to give you a loan because they want to make sure you can pay it back. They will look not only at your credit score and credit history but also at your income, employment history and debt-to-income ratio. A high credit score alone does not guarantee a loan.

Debt-to-income ratio

Mortgage lenders look at your debt-to-income ratio (DTI) in order to measure your ability to make monthly payments and repay the money you borrowed. If your monthly debt payments are $2,000 and your gross monthly income is $6,000, then your DTI is 33 percent ($2,000 / $6,000 = 0.333). Your income can include pay earned from your job, dividends, self-employment, alimony, child support or other sources if you receive the income on a regular basis.

Credit counselors recommend a ratio of 30 percent or lower to qualify for a mortgage.