How much good credit do I need if I want to buy a house in a few years?
September 3, 2009 5:54 PM   Subscribe

How much good credit do I need if I want to buy a house in a few years?

Hi, I'm a student, graduating in a year or two. I don't expect to have trouble finding low-paying salaried work ($20,000-$30,000) in my non-profit's field. I am in my mid-twenties. Up until a year or so ago, I had no credit. Then the housing market crashed, and I realized that I may want to be able to take out a loan to put toward a house in a few years. So I got a credit card. It initially had a $500 limit, and is now up to $1400. Once a month (always on time), I pay off my $35 phone bill through this credit card.

$1400 is nowhere near enough to buy a house! Lenders look at how much credit I have (and have had) available to me when they decide whether or not to loan me money for a house, don't they?

I could take a $5,500 interest-free student loan out and put it in some sort of online savings account or CD, then pay it back before I had to pay interest on it. (Speaking of which, do you have any good socially-conscious suggestions for either of those?) Would this make any sort of significant improvement on my credit as it will be looked at by potential lenders in a few years? Would it make more sense to just get a second credit card?

What other suggestions do you have?

I am in California for school, planning to move back to the Pacific Northwest in a couple of years.

Many thanks for all your answers.
posted by anonymous to Work & Money (9 answers total) 5 users marked this as a favorite
The fico forums are one place to look for more information about credit scores.

Your credit card utilization (e.g., if you're using just 10% of your available credit) is one part of your score over time. Then your total debt in relation to your come. Also the age of your average accounts. It's better to just have a few accounts open for a longer time then to open many different accounts.

So it's not necessarily good to have a gigantic amount of available credit if your income is low. You need to have income > (is greater than) available credit > credit being actively used.
posted by ejaned8 at 6:01 PM on September 3, 2009

Mortgage companies will typically look at your income relative to your overall debt, not the limit on a particular card, when determining whether they want to lend money to you. Be aware that paperwork requirements over the next several years will likely increase due to a general aversion to extending credit across the economy.
posted by dfriedman at 6:02 PM on September 3, 2009

Your available credit is one tiny piece of the puzzle. Most lenders look at FICO scores, which are a predictor of your overall creditworthiness, and they weigh the projected house payments against your monthly income to make sure house payments aren't going to be more than about 30% of that. If your credit scores are marginal they'll inspect other parts of your finances to figure how good or bad a credit risk you are.

For now the best thing you should do to prep for a house is get about 3-4 credit cards, preferably with no annual fee, and use them regularly to make them active but pay them off each month to maintain a $0 balance. I have heard some talk though about banks closing accounts that are paid off regularly, so you may want to read some of the stuff on to see if the wisdom on this has changed or if certain banks are doing this kind of thing. The other thing is to make sure you are never, ever late on payments to any creditor... I think you're allowed to be 30 days late before it hits the credit reports, and within 30 days you're just in trouble with that one creditor (usually limited to late fees and penal interest rates).
posted by crapmatic at 6:05 PM on September 3, 2009

Down payment and income level will determine more about a mortgage than anything else.
posted by blue_beetle at 6:55 PM on September 3, 2009

Not sure down payment is that important. We just got a loan on a 650 FICO and almost no down. Granted, it's a FHA loan, but all the same...

What we learned was that lenders are sometimes looking not so much for a high FICO or a large down payment, so much as a viable income and someone who has NOT had credit issues in the past year or two.
posted by krisak at 8:00 PM on September 3, 2009

The way buying a house works is, typically:

Suppose you want to buy a house that costs $100,000. (Most houses in most places will be more expensive, but this keeps the math easy)

You will bring three chunks of money:
1. a "down payment", which is money that you contribute in cash (really a check, but you need to have the money in your bank account, you can't be borrowing it on a credit card for example) at the time of the sale. Traditionally a good solid down payment is 20% of the cost of the house. You can get mortgages where you're putting down less than this, as low as 3% I think, but there are advantages to being able to put down 20% (you don't have to get "private mortgage insurance" which can be expensive). So, since you're just starting out, imagine you're aiming to have a 20% downpayment. On a $100,000 house, this means having $20,000 in savings by the time you want to buy.

2. Money to pay for "closing costs"; again, this is money that you (and sometimes the seller) contribute in cash at the time of the sale. These vary a lot but let's say they can be anywhere from $2000 to $10,000.

So, if you want to have a 20% downpayment for this house you need $22,000 - $30,000 saved up. This is what you'll build over the next few years, contributing to a Roth IRA (I believe the Roth allows you to take out money early if it's for a downpayment on your first house) or using other investments. You will want to talk to an investment advisor about this, but the earlier you get started saving the better off you'll be.

3. A loan for the rest of the purchase price. You will take out a mortgage for the remainder of the cost, so you'll borrow $80,000 on the house we're imagining. Your credit score will be part of what determines if you get the loan, or if you get it on good terms. The bank that loans you the money will charge you interest on it, over a time period that's usually 30 years. Having a better credit score can help you get a lower (better) interest rate. You will pay back the mortgage in monthly payments that function much like rent.

You can try a mortgage calculator to see the effect of interest rates, but for example: If we took out an $80,000 loan at 7%, our first monthly payment would be $534. If we took out the same amount at 9%, our first monthly payment would be $643. In this case, two percent difference in interest = $100 a month difference.

So for now, you should be saving money for the down payment, and gradually building credit by paying your bills. Good credit will also help you get loans for cars or other things.

BUT - Build good credit gradually, not with shenanigans; if you charge a lot to your card, there's a risk you'll end up going a month late and then racking up interest charges and late fees and so on. Be very careful about this stuff, because it can easily snowball if you're not meticulous about it.
posted by LobsterMitten at 8:08 PM on September 3, 2009 [2 favorites]

$1400 is nowhere near enough to buy a house!

Just to address this directly, in case you are not kidding: this is a confusion. The credit limit on your credit card is different from the amount of money you could borrow from a bank. The amount of credit you can get even varies from card to card. One credit card company might give you a $1400 limit, only raising it a little every year, while another might give you a $5,000 limit as soon as you graduate and get a job. If you wanted to borrow money for a car or house, you would go directly to a bank or credit union and talk to them about their loans. They have different requirements and different interest rates, etc, from credit cards.

Keep paying your card off every month, is the main thing. Open one other card if you want, and keep it paid off too. I've only ever had one card, and I have excellent credit. Don't worry too much about all the psych-out shenanigans about optimizing your credit score, until you're within a year or two of buying or unless you get some weird feedback when applying for a loan.
posted by LobsterMitten at 8:18 PM on September 3, 2009

Lobstermitten's advice is very sound and should be heeded.
posted by dfriedman at 8:26 PM on September 3, 2009

Lobstermitten is correct. Your credit score is different from the amount of credit you have. Because if you already had enough credit to buy the house, you wouldn't need to get a loan.

Lenders use the credit score to determine their level of risk in lending you money. The higher your score, the less risk they have and the more willing they will be to give you a better deal.

What you are talking about, I think, is your credit history. That is in part what determines your score and your creditworthiness. Having NO history is risky for the lender; they don't know whether that means that you never needed to borrow anything, or whether you are a deadbeat who couldn't get it together enough to even try to borrow anything.

Part of building a good credit history is having access to a significant amount of credit, and using it responsibly. They'd much prefer to see someone with a history of not going into deepening debt with a lot of credit access, than none at all. That's why people are advised to get credit cards and use them responsibly- it shows a pattern of good behavior.

The only caveat is that if someone has a LOT of available credit that they could use, it starts to go the other way. Lenders get hinky when they see someone who could borrow themselves into bankruptcy in a matter of a few months.

I have never been turned down for a loan, and have always been offered more than I needed. What I do is funnel all my bills and spending through my credit cards, and then pay them off every month. My impression is that this builds a nice history of good behavior.

Another thing is to dip your feet into larger loans. Suppose you've saved up enough to buy a car, and are going to pay cash. That's awesome. But it doesn't contribute to building a good credit history- that transaction would be functionally invisible to credit reporting agencies, and to your lenders. So, get a car loan instead. Maybe it costs you a few percent more, but that's a low price to pay in comparison to being stuck with a less than optimal home loan.
posted by gjc at 7:05 AM on September 4, 2009

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