Credit: Why You Can’t Buy a Home Without it

In today’s economy, the word "credit" is often thought of as a foul word. Many believe that using too much credit is a large reason why the economy—and the world economy in general—has taken a dive over the past few months. While excessive and improper use of credit isn’t good, having credit isn’t bad either. Case in point: Real estate.

If you are interested in buying real estate, you must have a credit record. Without a proven credit record, purchasing a home through a mortgage loan is impossible… and that’s not all. It’s not enough to just have a credit record; the type of credit profile that you have—desirable or undesirable—has a direct effect on your ability to purchase real estate.

The first major way in which your credit record can help or hinder you when trying to get a mortgage loan is consideration; many mortgage lenders will not even consider offering a mortgage loan to you if you do not have "enough" credit lines. What’s enough? That’s subjective. Generally, most mortgage lenders just want you to have sufficient credit for them to get an accurate picture of how you manage credit. In many cases, having three accounts is sufficient, particularly if the credit lines you’ve been extended are large. The consequence of not having "enough" credit is simple: You’d be considered an "undesirable" mortgage loan applicant and a mortgage lender will not loan you money for a home because they cannot predict whether you’ll repay a loan they provide.

Once a mortgage lender is certain that you have an established credit history and are therefore desirable on that basis, it will consider you for a loan. However, the mortgage loan lender is not done perusing your credit profile; next, a mortgage lender will focus on how well you’ve managed the lines of credit that others have extended to you. In regard to this aspect of your credit profile, a lender will be looking for two things: (1) To see if you’ve habitually paid your debtors on time and (2) to determine how much of the credit extended to you you’ve actually used, which is your debt-to-credit ratio. If you have a number of credit lines and have hardly used any of them, your debt-to-credit ratio will be low; if you’ve used most, if not all of the credit extended to you, your debt-to-credit ratio will be too high. As far as paying debtors on time, lenders just want to know that you regularly repay your debts! The consequence of your profile reflecting poorly in either area is that mortgage lenders will view you as an undesirable applicant and won’t offer you a mortgage loan. In the lender’s mind, you’d be too much of a risk due to either pure irresponsibility or owing too much to too many others!

So, based on the above, would a mortgage lender want to offer you a loan? If not, you’ve got some work to do to get your credit profile in order. If so, great! You’ll likely be able to get a mortgage loan…but that raises another question: What kind of mortgage rate will you be eligible to receive on that loan? To answer that, mortgage lenders will once again refer to your credit profile.

At this point, a mortgage lender will either "reward" you for managing credit well or "penalize" you for managing it poorly. If you’ve proven that you’re capable of managing credit well, a mortgage loan lender will reward you by offering you a low interest mortgage rate. Conversely, if you have been less than diligent with your payments to creditors or have driven up your debt-to-credit ratio but are still a somewhat desirable applicant, a mortgage loan lender will likely offer you a mortgage loan but your mortgage rate will be higher. And trust me, the mortgage rate on a loan can make a huge difference in your mortgage payment; a mortgage payment for a 5-year, $150,000 loan with a 6.5% mortgage rate would cost $2,934.92 per month but if you had a less desirable credit profile, the mortgage rate you receive could be 9.75%. In that case, the same loan would cost $3,150.28 per month, all because of the higher mortgage rate.

As you can see, credit plays a significant role in not only your ability to obtain a mortgage loan but also the affordability of the loan. Therefore, if you’re thinking of buying real estate and obtaining a mortgage loan to do so, make sure that your credit profile is the best it can be; it’s as simple as establishing relationships with creditors and making regular, on-time payments. Do that and you won’t have any trouble qualifying for a mortgage loan. Plus, you’ll prove that using and having "credit" is actually a good thing.