Renting as a Way to Strengthen Your Credit Report
Your dream is to buy a house, but all you can afford to do now is rent. You're wondering if renting can actually help you attain your goal of owning your first home. The answer is a definite yes, if you use the time you rent to build up your credit report and improve your finances so you can qualify for the best mortgage rates.
Paying your rent on time every month certainly helps to prove to a mortgage banker that you will pay your bills on time, especially your mortgage. In today's market that's a big step forward.
You also can use your time as a renter to improve your chances of getting an even better deal by taking a number of key steps while you're renting:
Step 1: Repair Your Credit Report, if Necessary
Get a copy your credit report from each of the three credit reporting agencies, Equifax, Experian and TransUnion. Review all three reports and check for any errors, such as accounts that are not yours, late payments that are not accurate, credit limits that are not right or anything else that may be shown in error.
At the end of the report you'll get a page that allows you to report any errors. Follow the instructions for correcting any errors with each of the credit reporting agencies. Once the credit reporting agency has corrected the errors, it will send you a corrected report. Check it to be sure all the information is now correct. If not, repeat the process. This can be frustrating and take a few tries, but it will be worth it in the end if it improves your credit score and helps you get a better mortgage deal.
Fixing errors on your credit report can take months to do, so start work on it right away. The sooner you repair your credit report, the faster your credit score will start improving.
Step 2: Pay Down Debt Using a Round Robin Approach
If the primary reason you want to pay down debt is to improve your credit score, the best way to do that is with what's called a round robin approach. With this strategy, you start by paying down all your debt to about 30 percent of the credit limit on each of your credit cards. That will help improve your credit score. Then work on getting down to 20 percent of your credit limits and finally down to 10 percent of all your credit limits.
When all your cards have a balance that is about 10 percent of their credit limits, you will likely see your credit score jump dramatically. You can expect to see a jump between 30 and 70 points when you reach this goal. If you've had a history of late payments and now are paying all your cards on time, that alone could increase your credit score by 40 points.
Step 3: Start Saving Your Down Payment
As soon as you have enough cash to work with after starting to pay down your debt, begin saving for the down payment on your new home. While you can set a goal of just 3.5% of the mortgage value to get an FHA loan, you will get a lower interest rate and avoid mortgage insurance costs if you're able to save for a 20 percent down payment. On a $150,000 home, that would be $30,000 plus about $5,000 to $7,000 for closing costs.
If you don't want to wait, you can go ahead when you have enough saved for a 3.5% down payment on an FHA loan and plan to refinance into a less costly loan several years down the road. As house prices recover, you may find that the value of your house increases enough to help you reach your goal of a 20 percent down mortgage, which will give you access to the best interest rates. In that scenario, you also won't have to pay mortgage insurance premiums.
When you do start paying the mortgage each month, remember most of the money goes toward interest in the early years of a mortgage. If you can afford to put an extra $50 or $100 toward principal each month, that will help you build equity faster and get you closer to buying your dream home.
You may not be able to afford that dream home right now, but with interest rates low and houses more affordable in many areas, you can get a head start by paying down the mortgage on a smaller place first. Hopefully as the housing market recovers, you will see your equity grow. Add to that the money you pay toward the principal balance of your current mortgage and you may be able to afford your dream home five to ten years down the road.
The key is to use this time while you're renting to concentrate on getting your credit report in tip-top shape. That way, when you're ready to jump in to the housing market, you'll have access to the best rates possible.
Lita Epstein has written more than 25 books including The Complete Idiot's Guide to Improving Your Credit Score.