How Your Credit Can Affect Homeownership

Real estate remains an important asset for people to acquire and hold throughout their lifetimes. Since 2008, for many people, owning real property such as a primary residence or an investment property has been an elusive goal. Those who own homes may be blocked from refinancing because of previous credit problems or loss of income.

For still others, purchasing or refinancing real estate can be difficult after the death of a spouse or a divorce. If income decreases, lenders evaluating a new application for a loan may find that the key financial ratios are not met. These can include ratios showing what percentage of monthly income must cover property expenses before other essential expenses are met. If the ratio is too high, lenders are reluctant to lend. These and other personal finance ratios can help lenders predict whether a borrower can afford the monthly payments for a new or refinanced home purchase.

Credit scores are arguably the most important determinant accounting for the interest rate quoted to a prospective borrower. Credit scores are dynamic and change throughout one’s lifetime. Managing credit for two or more becomes important after marriage. Credit histories can be separate or become intertwined, and one spouse’s bad credit can affect the ability of both spouses to get loans. (For related reading, see: Is My Credit Score Good Enough for a Mortgage?)

Getting credit back on track may involve some simple tricks, but may also require some perseverance through times of reduced spending. Anyone caught in a foreclosure or a short sale for instance knows that this event can persist on a credit report for years.

Credit Scores: What They Are and What Factors Affect Them

Credit scores include what is called a FICO score, which is created by Fair Isaac Corporation. Lenders use these FICO scores along with other information on individual credit reports to determine how risky the borrower may be for repayment of loans. These scores factor into the interest rates quoted and decisions on whether to extend credit and for how much.

Credit ratings agencies weigh different components of credit history differently to arrive at a score ranging between 300 and 850. In general, payment history accounts for 35% of the score and length of credit history is 15% of the score, followed by percentage points for new credit (10%) and credit mix (10%). 

People can improve their credit scores by paying bills on time and managing credit lines so each account is not maxed out to its limit, says Kathryn Davis, CEO of Balance, a credit repair services nonprofit in San Francisco. Some tips for managing credit scores include asking for larger credit limits on existing lines but not using them, keeping open the oldest accounts and keeping a strong mix of credit lines, including credit cards, installment loans for autos or other term purchases, and mortgages. (For related reading, see: Credit Repair: How to Improve Your Credit Score.)

In a couple relationships, it is important to build and manage credit in the names of both spouses, assuming both spouses may eventually desire to be on the title for purchase of real estate. Even a spouse with poor credit can rebuild his or her profile by using prepaid cards and meticulously paying back small amounts borrowed monthly.

Community Property vs Separate Property: Are Credit Scores Shared Assets?

In community property states, assets acquired during marriage using salaried income are presumed to be community property. For instance, in California salaries are judged to belong to both spouses. Credit scores however belong to individuals unless there are joint accounts opened. Then the behavior of both spouses can affect the credit scores, says attorney Joann Babiak. In the case of divorce, any liens placed on real property don’t immediately affect credit, as they do not displace the first and second place of the lenders. However they can affect title and any liens would have to be settled if the property is sold or refinanced.

In settlement of property pursuant to a divorce decree, “it is important that the spouse not keeping the house obtain a quit claim and an order to refinance from the spouse staying put,” Ms. Babiak says. “Otherwise the spouse without the home may remain on title and have a credit event if the spouse in the home stops paying.” (For related reading, see: Divorce and Mortgage Payments: What You Need to Know.)

Financing Property, What Lenders Look at

Mortgage experts looking at a financing application want to see cash that is available for the financing transaction to have been on deposit for some time. They call this “seasoning,” says mortgage consultant Brittany Keyes of Princeton Capital Mortgage. Credit scores are important in determining the rate of interest quoted. Any derogatory comments or events on a credit score should be older, not recent.

In the case of two spouses and multiple credit scores quoted by the credit reporting agencies, the middle scores are given the most weight, Ms. Keyes says. Conventional lenders also impose criteria for loan-to-value ratios and the building-code compliance of financed properties, she said. People who want or need to borrow outside of conventional lenders would be forced to pay higher interest typical of the private money market.

Income history is also important, especially if a couple is using two incomes to qualify. If only one of the two spouses has a good credit score, however, the couple may choose to qualify with one income only presuming that the person with the higher income as the better credit score. 

Pre-Qualifying Before Shopping

Anyone having credit issues or irregular income intervals should pay particular attention to their credit reports, which are available free from online services such as www.creditkarma.com, or from rating agencies on a yearly basis. Any errors should be disputed and cleared before seeking out a pre-qualification for a loan with a lender. 

Many if not most realtors will only show properties to people once they are qualified for a loan, unless the shoppers plan to buy outright or with an exchange of investment properties in a 1031 exchange. Realtor Toni Shroyer of Bradley Real Estate cautions that down-payment requirements for primary residences are usually less than for residential rental properties. Higher credit scores may also be required if one is buying and financing a rental instead of a primary residence.

“This may deter someone thinking he or she can buy a lower cost property in an inexpensive area of the state just to start building equity, as the requirements for buying a rental property may be stricter,” says Ms. Shroyer. “In this case, getting a foothold in an expensive real estate market like Marin County with a transfer of equity from another property may not be the best strategy.”

After a credit setback, it may be better just to save up more money with which to start investing in property in a better, more predictable housing market than risk getting stuck with a property in a depressed area, she said. “Getting that preapproval from a lender guides the buyer in determining what he or she can afford and steers the person toward the appropriate price range in whatever market he or she hopes to buy,” she says. (For related reading, see: Buying Your First Investment Property? Top 10 Tips.)

Taxes Matter

The decision to file married separate versus joint when managing tax liabilities may turn more on how much one spouse trusts the other in truthfully reporting potential income tax liabilities. If one spouse is found at fault for hiding or underreporting income, the Internal Revenue Service can impose liens to collect underpaid or evaded taxes. These liens may be imposed on salaries before they are paid to the recipient, affecting earnings power to service any loans already in place. 

An uninformed spouse may do better to file separately in this case to avoid facing penalties and consequences for the behavior of the spouse who cheats. Tax liens may or may not show up on a credit report, depending on if they are placed against a property only.  However, in the event of a refinancing or sale of the property, these liens would have to be settled.

Unforeseen Income Consequences

Many baby boomers entering the golden age of eligibility for Social Security are startled to learn that their decisions to default on student loans can affect their Social Security income. The resulting squeeze to benefits payments can affect the ability of these retirees to service home debt. The paperwork required as a workaround can be cumbersome and must be submitted annually. (For related reading, see: Seniors: Before You Co-Sign That Student Loan.)

Maintaining good credit is important at any age, as credit scores change throughout one’s lifetime. Bad credit may be an inconvenience when one is trying to refinance or purchase a home. However, unpaid student loans can be a recipe for disaster in retirement if the retiree will partly rely on Social Security income to pay down the mortgage. 

(For more from this author, see: How to Use Tax Mapping to Cut Taxes in Retirement.)