Q: I want to buy my dream home, but it’s not easy. I need to have great credit, and I don’t have any credit at all! Where I live, there are lots of houses on the market for cheap. I have the income and a good job, but my lack of credit is the problem. Any advice?
Q: I’m a real estate agent, and I often work with young adults who have graduated from school, have good income, but no credit. What is your advice for them to help build a strong credit record so they can qualify for a mortgage?
A: Establishing credit is an issue that faces every single person who wants to buy a home at some point in their lives. Many of us Gen X and Yers dealt with the issue less than consciously by creating credit on autopilot, just in the course of getting through college and otherwise launching our lives. Even 10 or 15 years ago, it was extremely common for young people to take out student loans, car loans and basic credit cards well before they sought to buy a home, unwittingly building a credit history for better or for worse.
Once the recession hit, young people started to be much more conscious about racking up crazy credit card and student loan bills willy-nilly, knowing that they might not be able to get jobs to pay them off. Many chose to go to less expensive schools they could more easily afford without debt; many others sought vocational and other sorts of job training. Even those who did go into educational debt were more careful than previous generations about taking on other sorts of debt, like credit cards and car loans.
I’ve also heard this same question more than once from immigrants — people who’ve lived and worked in America, legally, for years, but have never established credit here.
Here are some simple steps for going about building the credit history it takes to obtain a home loan:
1. Open and maintain one to three credit accounts, over time. To establish the credit trade lines required to qualify for a mortgage, you’ll need to open a few credit accounts. Department store credit cards, bank credit cards, auto loans and gas cards are common starter credit account types.
If you apply and are rejected, consider (a) asking a parent to add you as an authorized user to one of their accounts or (b) obtaining a secured card from your bank, the sort of account where you post a cash deposit before you receive the credit card account, and your credit limit is based on the deposit amount you put up. These strategies can help you build just enough of a credit record to qualify for another account.
2. Open and use your accounts wisely. A sudden wave of credit applications actually depresses your credit score, so pace yourself. Try to open no more than one account every few months — max. Also, if you have credit accounts but keep them at zero balances, they don’t actually help create the track record of responsibly using credit that lenders are looking for.
Once you have a credit account, you must do two things to render it helpful in the mortgage approval process: (a) use it moderately — aim to keep your balance around 30 percent of the credit limit, and (b) pay it on time, every single time.
3. Involve a mortgage broker in your credit-building plans, and ask him about alternative trade lines. FHA loans are the most flexible when it comes to credit scores and credit accounts required. The basic requirement is three credit accounts, one of which must have been open at least 12 months. As usual, FHA loan underwriters will look at the borrower’s credit record as reflected in the traditional credit reports published by Experian, TransUnion and Equifax. But with an FHA loan, if the wannabe borrower lacks three credit trade lines on their credit reports, there are alternative ways of documenting a worthy credit history.
FHA will allow borrowers to provide 12 months of canceled checks, banks statements or account statements showing on-time monthly payments on the following sorts of installment accounts, as alternative trade lines:
- auto, health or life insurance.
- cable or cell phone accounts.
- child care expenses.
So, before you go out opening accounts, talk with your mortgage broker. If you have a student loan or even a single credit card or car loan account, you may be able to use alternative trade lines to document the track record of on-time monthly payments that lenders want to see.