Your money behaviours impact if you get a mortgage loan and the interest rate you will be offered. Lenders want to make sure you are a good risk, that is, if you will make your payments on time so they rely on your credit score and debt-to-income ratio. Each lender has specific eligibility guidelines and mortgage terms they can offer. If you have a higher credit score and lower debt-to-income ratio you are likely to manage your monthly debt payments well and be a better risk. Therefore, you may be offered a more favorable mortgage rate, which can result in lower payments and less interest paid over the life of the mortgage.
Left brain: HIGH Credit Scores and LOW DTI = Good behavior and a good risk!
Know Your Credit Score
Your credit score is a three-digit number which represents the probability you will pay your bills on time, hence be a good lending risk. This little number will impact your ability to secure a mortgage, and the interest rates and other terms you may be offered. Higher scores can mean that you have responsible credit practices in the past. While there are different credit scores and credit scoring models the reports from Equifax®, TransUnion® and Experian® are used.
Credit score scale:
300-579: Poor
580-669: Fair
670-739: Good
740-799: Very good
800-850: Excellent
Factors included are:
Payment history: This includes information on missed or late payments, bankruptcy filings and debt collection on open credit accounts in your name.
Credit utilization: The debt-to-credit ratio represents the amount of revolving credit you’re using divided by the total revolving credit (credit cards and lines of credit) available to you. Your goal is 30% or lower.
Length of credit history: A longer credit history can improve your score because it provides more data on your financial behaviour. This is NOT intuitive; you need to use credit tools to build your good behaviour patterns! You need a healthy credit score to get a mortgage. You need to have good habits such as paying it off monthly, and keeping the balances below 30% of the limit. Tip: Keep older, active accounts open, even if they're not used frequently.
Types of credit: Having a variety of credit accounts, such as credit cards and loans, can be helpful. Having a mix of both revolving and installment accounts can show lenders and creditors you’re responsible with different types of credit.
“Hard credit” inquiries: Applying for a new type of credit prompts what’s known as a “hard inquiry”. Several hard inquiries within a short period of time can negatively impact your credit score as it suggests potential financial instability. This means shopping around for credit deals will hurt you.
Calculate your Debt-to-Income Ratio
The Debt-to-Income (DTI) compares your total monthly debt payments to your total monthly income. The DTI is an easy way to measure the overall health of your finances. It is a key factor that lenders use to determine if you’ll be approved for a mortgage. After you apply for a loan, the loan officer (underwriter) will check your debt-to-income ratio to see if you can afford the loan payments and decide if you are a good risk for the loan. The lower the number the better your chances!
Check your DTI to see if you have too much debt for your income. If your debt ratio is too high, then reduce debt before you apply. As the DTI rises, you can expect to pay higher interest rates. The loan may also have more restrictive terms. If your DTI is too high, you won’t get approved.
TIP: Be patient before you start chasing another dream. Wait to make a big purchase with debt, move, etc.
Your DTI includes: All your monthly debt payments PLUS insurance
Total Net (after-tax) Income
Your monthly fixed payments may consist of:
• Monthly rent or house payment,
• Monthly alimony or child support payments
• Student, auto, and other monthly loan payments
• Credit card monthly payments (use the minimum payment)
• Other debts
What does the DTI ratio number mean?
Under 36% This is a good level which should make it easier to be approved when you apply for financing. Ensure your credit score is high enough to qualify.
37-41% This is within a normal range for your income. However, you may need to eliminate some debt depending on what it is and what loan/debt tool you are applying for.
41-45% Having this much debt will make it difficult to get a loan or a credit tool. Reduce your debt with lump sum payments and stop making new charges on your credit cards until the balances are less than 1/3 of your limit.
50%+ This level requires you to reduce or eliminate debt before you apply for a loan, etc.
Right brain: Check Your Money Scripts & Habits to get a Better Mortgage Rate
Reducing debt doesn’t happen instantaneously but you can do it! Prioritizing debt payments and mortgage payments will take some restructuring of your budget but you can have confidence when you walk into the lenders office and satisfaction when you walk out pre-approved!
To obtain your financial goals a sacrifice is required. Challenge yourself to stop small purchases such as buying coffee, a lottery ticket, etc. Ask yourself each time you are on the way to pay, “Do I need this or want it?” If it’s “a want” put it back or give it to the cashier and say, “I am going to have my own home.”
The voice that says: “I didn’t buy anything big lately” needs to be stopped with facts. Check your credit card or lifestyle account balance to confirm you are spending less than you have in the bank before you go out for dinner, rent a movie, etc. It is easy to forget what we bought last week.
Protect your credit score and ensure timely payments by setting up Automatic Bill Payments or reminders so your bills are paid on time. This can help provide freedom because you know you basic bills are covered before you spend.
Set a Delay Purchase Minimum for yourself. Decide on an amount that you must walk away from purchasing and wait 48 hours. This helps avoid impulse purchases based on the script “I must have this today”. Replace it with “I need to think about this”. If it’s a really good deal tell yourself “there are always good deals” or “it’s only a good deal if I can afford it, can I?”
It is helpful to set a Purchase Negotiation Threshold such as $50, $100, or $400. If you are facing a purchase at the threshold you will benefit from checking in with your partner before going beyond your budget. The voice in our head says: “I can afford it” but you need to focus on facts to save enough.
Stay informed by annually checking your credit report to catch and dispute inaccuracies that could lower your score.
Tip: If you spend $28/ day on unplanned spending you will throw away over $10,000 a year! You can save this toward your down payment instead.
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