Slimming down the waistline may be the most popular resolution, but the advent of a new year is also the time many Americans resolve to slim down credit debt. Prospective home buyers have even more incentive to whip their credit into shape -- leaving a bad credit score to fester can be disastrous later, when the time comes to purchase a home.
Long after the Great Recession of 2008-2009, an abominable credit score will still follow home buyers around as retribution for past credit sins, compounded by stricter mortgage loan standards from government-sponsored mortgage giants Fannie Mae and Freddie Mac.
"It's all changed -- it used to be that you have a heartbeat and you get a loan. Now they want your firstborn," says Robert Reid, president of Garden City Mortgage.
Though it may be harder than ever to get a loan, studies show an improvement in overall reduction of debt, a determining factor in loan qualification.
The total outstanding household debt in New York State is down to $1.37 trillion since its peak in 2008, according to a quarterly report by the Federal Reserve Bank of New York. Meanwhile, newly approved mortgages rose to $521 billion in the third quarter of 2012. As another indication of a statewide improvement in creditworthiness, balances on credit cards have fallen 22.4 percent since 2008.
But despite the improvement, banks are still cautious about making mortgage loans. "Most people are not qualifying by leaps and bounds. Most are qualifying by the skin of their teeth," says Gregory Frank, regional manager at Guaranteed Rate, a mortgage brokerage firm based in Garden City.
So what does it take to become the ideal loan candidate? Long Island mortgage brokers and housing professionals give some advice to polish up your credit before plunging into the housing market:
1. DON'T BUY A CAR
Before starting the house hunting process, avoid taking on any additional debt, which includes credit cards, home equity lines of credit and mortgages, and car loans or leases. "When you buy or lease a car, you're going to add a monthly liability. When we calculate your debt-to-income ratio it's going to count against you," says Frank.
A higher debt-to-income ratio, or DTI, means a lower FICO score, the way in which banks and lenders measure the credit risk of doing business with you. Save large purchases like cars and furniture until after you get approved for a mortgage. Even if your bank account can afford the payments on that new Dodge Charger, your DTI might not.
2. DON'T CLOSE A CREDIT CARD
Closing unused cards is one of the most common pieces of credit advice, but it does not improve your credit score at all. In fact, closing cards can wreak havoc on your credit score by increasing your revolving utilization percentage, or the percentage of your available credit card balance that you use.
"When you close out a credit card, you are terminating your ability to manage credit," says Frank. "If you close out all your cards and leave one with a large balance on it, FICO is going to think you're maxing out your credit cards. Leave them open, even after you are mortgage-approved.
3. DON'T CHECK YOUR CREDIT FREQUENTLY
Any time you apply for a loan or credit card, the creditor or bank will submit an inquiry to retrieve your credit score, which will count against you on your credit history by being recorded in your credit report. "It looks like you're getting rejected over and over again. It shows you to be a bit irresponsible," said Chris Gonzalez, executive vice president of Academy Mortgage in Bellmore.
If you just want to find out what your credit report is, visit a local, HUD-certified housing agency (such as the Long Island Housing Partnership or the Community Development Corporation of Long Island) for a free credit counseling session.
Your credit counselor will do a "soft pull," which is an inquiry that doesn't adversely affect your credit score. To get a mortgage, visit a mortgage professional, who can access a vast network of banks and lenders but "hard pull" your credit only once. If you go to all the banks yourself, you will have to run your credit over again for every bank you try.
4. DON'T TRANSFER ALL DEBT TO ONE CARD
If you get a great interest rate on a card, you might think it's a good idea to transfer all your credit card debt to that card. Though that interest rate is tempting, don't put a high balance on that card while zeroing out your other accounts. "You now have a new account fully maxed out, and others that are empty. That's not somebody we want to lend to, that's a risk," says Frank.
5. DON'T MAX OUT CARDS
You should only use under 30 percent of your credit limit on each card. So if you have a $1,000 limit, you should never put more than $300 on it at a time. If your cards are constantly maxed out, "when [creditors] look at you they see a greater chance of default than someone who is using their credit wisely," says Eileen Anderson, senior vice president of the Community Development Corp., a Centereach-based nonprofit housing agency that provides free credit and financial wellness counseling, among other housing assistance programs, to Long Islanders in need.
Aside from paying down your balance, increasing your credit limit will also lower your "revolving utilization" or credit use percentage. Call your creditor and ask to increase your credit limits.
6. DON'T LET YOUR CARD GO UNUSED
Maxing out your cards is a cardinal sin, but having unused credit cards doesn't help you either. "It is not a matter of having credit cards, it's a matter of using credit wisely," says Anderson. "Just having them does nothing to build credit."
A zero balance also risks losing that line of credit altogether. Since your creditor is losing money every month you don't use the card, the company might close the unused credit account for you (and remember -- you don't want to close out any cards). To keep the account active, make occasional purchases with your credit card.
7. DON'T MAKE PAYMENTS LATE
"One of the worst things you can do is be late on a mortgage if you already have one," says Reid. Whether your debts include credit cards, a current mortgage or car payments, "the most important thing is to pay on time, even if it's just the minimum payment," says Carol Yopp, program manager of the Long Island Housing Partnership, a nonprofit, HUD-certified housing agency based in Hauppauge.
MYTHS THAT HURT A CREDIT SCORE
Here are five credit score misconceptions.
STUDENT LOAN DEBT IS GOOD DEBT
The Federal Reserve Bank of New York reports that student loan debt increased by $42 billion in the third quarter of 2012, and has continued to increase while other kinds of loans have decreased. Many New Yorkers heeded the conventional wisdom that called them to weather the recession and subsequently poor job market by going back to or staying in school.
Although education may have added to your marketability, it has also increased your debt-to-income ratio, potentially diminishing your desirability in the housing market. Student loan debt won't affect your credit score if it's still in the deferment period, but lenders will still factor your future student loan payments into their calculations of your DTI when determining your current mortgage readiness.
If your student loan debt pushes your DTI over 40 percent, they will consider you a risk to lend to. And if your student loans are already out of deferment, your monthly payments will factor into your payment history and affect your credit score.
ONLY ONE SPOUSE NEEDS GOOD CREDIT
If you have good credit but your spouse has bad credit, the banks will go by the worse of the two when determining your creditworthiness as a couple. If your spouse's credit score is bad, your only option is to leave his or her name out of the mortgage (you can still include it on the title).
IGNORE IT AND IT WILL GO AWAY
When you avoid paying, whether it's for a cellphone contract, retail credit account, hospital visit, or unpaid taxes, a judgment will be filed against you, and can stay on your credit for five to seven years.
"People will risk buying a house because they refuse to pay a credit card at Macy's," said Robert Reid, president of Garden City Mortgage. "It's going to follow you around until you settle with them," he adds. Be sure to keep the receipts for judgments you have settled.
Sometimes even though a judgment was settled years ago, it might not have been updated and could still be affecting your credit.
MY SCORE IS GOOD ENOUGH
While your current score may qualify you for a loan, raising or lowering your credit score by just 20 points can make a difference in your mortgage interest rate. Credit scores south of 660 are in the danger zone, whereas credit scores over 740 are considered ideal.
I ALONE AM RESPONSIBLE FOR BAD CREDIT SCORE
Visit a mortgage broker to check your records against your credit report to ensure you aren't being held accountable for someone else's mistakes.
"Sometimes when creditors enter information into the system, they get one digit off in the Social Security number, and that's someone else's Social Security number," said Reid.
While many clerical errors can be disputed by providing proof, you might be stuck with other marks against your credit that aren't your fault. "If you're divorced, you better check your credit, because odds are when you were married you took out a lot of credit jointly and you don't know what that person has done since your divorce," said Reid. Your children's credit habits might affect your credit as well if you've ever cosigned for them.