Six Ways to Help Borrowers Address Credit Scores
When I was applying for my first mortgage – a subprime loan with a high rate and excessive fees – I knew I had some issues with my credit. I was embarrassed by it.
I think that embarrassment and the stigma of poor credit is a real impediment for many folks. Many first-time homebuyers are afraid to face credit problems directly to fix them, and often just hope the problem areas don’t hurt their chances of getting a mortgage.
Most consumers are good about monitoring their score, but often don’t fully understand how it impacts their financial situations and ability to buy a home. And with the coronavirus (COVID-19) pandemic in full swing, mortgage lenders and investors are closely monitoring credit scores, which can keep potential borrowers from getting a mortgage that they would have otherwise qualified for pre-COVID-19.
Now more than ever, the mortgage industry needs to help educate and guide consumers in strengthening credit for homeownership. This can help first-time homebuyers, particularly in the wake of COVID-19 and resulting financial uncertainty.
It can also help them avoid some misconceptions so they can improve their credit before a mortgage becomes too far out of reach.
Here are several insights on credit scores that lenders can act on to help first-time homebuyers tackle this key element of the mortgage process.
1. Lack of knowledge of what’s in the score. The Consumer Federation of America conducts an annual survey that looks at consumer intelligence about credit scores. The latest survey showed the lowest level of credit knowledge in the past eight years; yet, more respondents considered it excellent or good. Some factors consumers most often fail to consider include the length of credit history, the types of credit they have, and how often they apply for new credit.
Key Takeaway: Help potential borrowers realize that a basic understanding of credit is an important first step in homebuying.
2. Misconceptions about how high credit score needs to be. Following the housing crisis, consumers heard a lot about higher credit score requirements for buying a home. Many still believe it’s hard to qualify for a mortgage, and some lack confidence in how to build their credit score. A 2019 Freddie Mac survey showed that, of renters who plan to purchase a home, 20% of low income and 16% of middle-income renters said they had low confidence in their knowledge of building credit in preparation for a home purchase. An even higher percentage—26% and 19%, respectively—lacked confidence in their knowledge of personal finances and credit.
Key Takeaway: Help prospective borrowers set realistic credit score goals and share tips on how to achieve it.
3. Unfamiliar with the importance of pre-qualification. Many first-time borrowers don’t know the difference between pre-approval and pre-qualification, and some mistakenly assume that pre-qualification will hurt their credit score. According to the same 2019 Freddie Mac survey, only about 9% of renters who planned to buy in the next two years had been pre-qualified as they prepared to purchase a home.
Key Takeaway: Explain to borrowers that pre-qualification only requires a soft credit pull—inquires that don’t affect credit scores—and help them understand the advantages of it. A borrower’s greater awareness of their budget demonstrates to sellers their commitment to buying and helps prepare for closing.
4. Not knowing how to resolve credit disputes. Consumers are doing a better job of occasionally checking for errors on their credit report, but many don’t know what to do when they find them. Credit agencies have been slow to improve the dispute process, but complex data collection, data breaches and other challenges make it no easy task.
Key Takeaway: Provide guidance to prospective borrowers on how to resolve mistakes—for example, reporting errors to federal agencies—and diligently stay on top of the process.
5. Unaware that homeownership can improve credit over time. Consumers may be fearful of the short-term dip in credit score following a hard credit inquiry during the mortgage process. Help borrowers reduce their risk by advising them to stay within a 30-day window while shopping for a mortgage.
Key Takeaway: Explain how, after a few years of making prompt mortgage payments and building equity, borrowers may see their credit score go up.
6. Credit mistakes after buying a home. It’s natural for new homeowners to want to buy furniture and other items for their new home. But as their monthly costs may increase with homeownership, such additional expenses may negatively impact their credit.
Key Takeaway: Encourage potential borrowers to resist the urge to apply for store cards to get discounts on their purchases and remind them to stay below 30% of available credit on all cards.
Financial Education Resources Can Help Future Homebuyers
A solid understanding of credit scores and how to manage them remains one of the biggest homebuying obstacles for first-time buyers, particularly in the affordable housing market. Along with the key takeaways above, lenders and other mortgage professionals can help future borrowers improve their credit education through innovative financial education programs and tools.
When I was buying my first home, resources to help me better prepare for the mortgage process were not readily available. If they were, it would have helped me qualify for a better mortgage with lower rates and fees, saving me thousands of dollars. However, today, there is a wealth of information and support that can help first-time homebuyers to understand the mortgage process as well as their credit scores.