Homebuyers need a good credit score even with 20% down

Credit scores have never mattered quite as much as they do now, says Bob Walters, chief economist for Quicken Loans

In this new era of tight credit, having a big downpayment no longer guarantees you’ll qualify for a mortgage. Starting in mid-December 2009, mortgage finance giant Fannie Mae now requires borrowers with a 20 percent downpayment to have a credit score of at least 620. Previously, the cutoff was 580.

Fannie Mae buys loans, provide an important source of financing for lenders. For that reason, its guidelines are considered the gold standard for mortgage loans. Most banks are expected to adopt the new standards, if they haven’t already.

In addition, Fannie Mae won’t approve loans for borrowers with a 20 percent downpayment if more than 45 percent of their gross monthly income goes toward debt. Fannie Mae didn’t disclose the previous debt limit, but it was higher than 45 percent, says Fannie Mae spokesman Brian Faith.

The higher standards could frustrate buyers hoping to take advantage of low interest rates, depressed home prices and generous tax breaks that were recently extended until May 1, 2010. Even buyers who qualify for a mortgage may find that they’re ineligible for the best rates because lenders have tightened their standards across the board, says Gerri Detweiler, credit adviser for Credit.com.

If you’ve already found a home you’d like to buy, there’s not much you can do to raise your score before you apply for a loan. But if you’re just starting to tour open houses, there are steps you can take to improve your credit profile, including:

Review your credit reports for errors. Go to AnnualCreditReport.com and order your credit reports from the three main credit-reporting bureaus: Experian, TransUnion and Equifax. You’re entitled to a free credit report once a year from all three of the bureaus, but only if you go through this website.

Once you receive your credit reports, go through them and look for inaccurate information, such as accounts you never opened. All of the credit bureaus provide a process to dispute errors, says Craig Watts, spokesman for Fair Isaac, which created the widely used FICO score.

Pay off credit cards and other debts. One of the factors used to calculate your credit score is your credit utilization ratio, which measures the amount of credit you have outstanding vs. your total available credit. This ratio accounts for 30 percent of your score. Paying off balances will increase the amount of unused credit you have available, which will help your score.

But even if you’ve decided never to use credit cards again, don’t close your accounts. Closing a credit card account won’t help your credit score and could hurt it, Watts says. When you close an account, you reduce the amount of your available credit, which could hurt your credit utilization ratio.

Avoid opening any new accounts. Every new account you open is likely to drop your credit score, at least a little.

Filed under: Blog by Kim Bregman
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