Managing a credit profile has grown into a daunting task over recent years. And preparing your credit prior to buying a home is especially important to your future as a homeowner.
Related article: How to Prepare Financially before Buying a New Home – 10 Steps
But once they clean up their credit to buy a new home, many fail to continue to maintain it, letting their credit score drop and getting loose with credit.
We’ve put together the 10 most common credit mistakes new homeowners make, and how you can avoid them.
1. Failure to Continue Managing Their Credit Profile
Staying on top of a credit report is very important once a new home is purchased. Many people are exhausted from the process of getting into a home and prefer to take a break from credit management. Yet this mistake can produce far-reaching ramifications.
Steve McLinden of Bankrate, reports that credit scores take a dip for a period of time as mortgage payments gain some history. This can be up to 100 points and typically takes 6 months to 1 year to creep back up. “A mortgage that is honored to the letter is one of the best things a person can have on the credit report. It typically results in a higher credit score than before the home was purchased.”
Fortunately, consumers can receive a free credit report annually with AnnualCreditReport.com or check it free every month at Credit.com. Taking the time to track what’s going on will not only prevent damage, but can also be encouraging should the score be rebounding.
2. Being Late on Mortgage Payments
Unexpected expenses can come up at any given time, but pay attention to your mortgage. Being too late on a mortgage payment involves paying late fees, and a mark on your credit report.
In an article written on Dough Roller, Rob Berger said, “Most creditors won’t report a payment that’s just a few days late. If your payment is less than 30 days late, it probably hasn’t been reported to the credit bureaus yet. But once you hit the 30 day mark, expect your late payment to show up on your credit report. In fact, late payments will be categorized based on how late those payments are: 30 days, 60 days, 90 days, 120 days, 150 days, or charge-off. The more delinquent your payment is, the worse its effect on your credit scores.”
A credit score can be damaged fast, yet it takes anywhere from 9 months to 3 years to get that score to recover.
3. Adding More Debt after the Purchase of a New Home
Every credit decision after the purchase of a home needs serious consideration. With the excitement of owning a home, comes the desire to buy new items for it. Yet any credit card purchases will jeopardize a credit store that is already being challenged by a large mortgage.
Certified Financial Planner Ellen Derrick writes, “A lot of people buy this nice house, and then look at the ratty car sitting in the driveway and think, ‘We better buy a new car.’” Or the new home has a formal living room but no formal living room furniture. It’s a credit mistake to start upgrading right after taking on a mortgage debt. “You don’t want to get yourself into a pile of credit card debt just so you can keep up with the house.”
The best approach is to live in the new home as it is, while building a savings account to make new purchases rather than adding more debt on a credit profile.
4. Not Understanding Credit Utilization
Credit cards with a balance over 50% of the total limit will cause a credit rating to go down. For example, if the credit limit on a card is $1000 and there is an outstanding debt of $600 on the account, this will affect a credit score negatively. Owing $900 on a $1000 limit is much worse.
Simply getting under the 50% mark (preferably 30%) will positively affect a credit score. The lower the debt, the better the credit scores. The safest approach to new credit purchases is to consider if 50% of that purchase can be applied on the first billing cycle. If not, then it’s not worth the purchase and should be seen as being out of one’s budget.
“To keep it strong, aim for using less than half of your available credit lines,” says Sarah Davies, Senior VP of Research and Analytics for VantageScore. If you keep your balance below 50%, your score is not negatively affected, and keeping it below 30% is smart.” (CreditCards.com)
5. Having Too Many Credit Cards
Less is better when it comes to having credit cards. A wallet full of credit cards is typically a wallet full of debt. Consumers are tempted by introductory low interest rates, but many don’t monitor the increase in interest rates will hit.
Reading the fine print in credit card contracts is crucial and, unfortunately, consumers often don’t want to take the time for that and can get into serious trouble when the rates skyrocket without their knowledge. If closing some of your credit card accounts, be sure they are paid off before doing so.
Andrew Beattie of Investopedia states, “For banks, having many credit cards is a bad sign that usually point to a potential financial crisis in the making – even if they all have zero balance.”
6. Making Minimum Payments on Credit Card Bills
Financial planner Daniel Wishnatsky advises, “People don’t realize how difficult it is to pay off loans with a high interest rate. You’re going to be paying it for your next three lifetimes.”
Be sure to check the interest rates on credit cards to make sure eliminating the debt is doable. CreditCards.com has a great online calculator that will answer the question of how long it will take to pay off a debt with minimum payments. Many credit companies already include this information on your bill, so look at it closely.
For those who have already fallen into a credit crisis, there are vast resources on the internet to provide assistance with getting your credit card debt under control: use them.
7. The Effect of Poor Credit on Homeowners Insurance
Many homeowners are unaware of how many home-related needs are affected by a poor credit report. Homeowners insurance is just one of them.
Insweb.com is an insurance website that specializes in educating consumers about the vast world of insurance. According to Insweb, “The higher a homeowner’s credit score, the lower their risk level. Statistically, homeowners with good credit file fewer claims than homeowners with poor credit. As a result, they’re rewarded with cheaper homeowner’s insurance rates.”
8. Buying a Home without Having a Savings Account
Many new homeowners are not aware of all the hidden costs as well as financial exposures they will now face. Depending solely on income to manage home expenses is a common mistake.
The best scenario is to have a savings account with money set aside for unanticipated expenses. Even with the best home inspector, there is still the potential for natural disasters, equipment breakdowns, or even personal crisis that can cause a financial meltdown. And things like routine maintenance costs are often not added in as part of a budget, but should be.
Without a savings account, it is common to feel forced into getting a credit card to pay for unforeseen expenses, digging a deeper hole of debt. What if there’s water damage from a pipe bursting, or the sewer gets backed up into the basement? Or what if you lose your job? An emergency savings is crucial.
Dana Drake of Bankrate takes this thought a step further.
“Your lender wants to see that you’re not living paycheck to paycheck. If you have three to five months’ worth of mortgage payments set aside, that makes you a much better loan candidate. And some lenders and backers, like the FHA, will give you a little more latitude on other factors if they see that you have a cash cushion.
“That money will also help you with maintenance and repair issues that come up when you own a home. While repairs are sporadic, items such as a new roof, water heater or other big-ticket items can hit suddenly and hard.” (Chron)
9. Not Studying the Resale Value of Your Home
Since a new home is a prized possession, a common credit mistake is not having a true understanding of the real value of a home. In general, homes are not a reliable investment. They are only profitable based on the market and economy at any given time which is difficult to predict.
It is important to do prior research regarding the neighborhood, projections of its profitability, the strength of school zones in the location, and projections of the area value in the future. Will your perfectly quiet neighborhood become home to a new highway or busy shopping mall next year? Is the area prone to natural disasters, or crime?
Many of those looking to purchase a home don’t typically have such things on their list to investigate. Yet such data is critical to understanding the viability of such an investment and considering exposures it can create. A comprehensive look at such issues can be found on Trulia.com.
10. Managing Credit without Understanding It in the First Place
To say ‘the times they are a changing’ is a huge understatement in the 21st century. Gone are the days of simple credit card statements, simple bill payments, and using cash to pay for items.
This is an era of credit complexities crossing many more financial lines than ever anticipated. Credit mistakes are commonly made by those who make assumptions based on old information. Old information just doesn’t apply in most of the financial world. In this regard, it is important to stay abreast of what changes are taking place to make the best choices when spending money.
The Financial Planning Association is an excellent resource for consumers. People can obtain free educational literature on a variety of personal finance topics and their website even allows consumers to ask financial planning questions, and to receive an answer from an FPA member.
The “Buying a Home” section here at SuperMoney is also a great resource to use when learning about the current issues related to credit management and money. Have a question about credit, or homeownership? Contact us here.