First-time buyer guide #5: getting mortgage-ready

You’re in the homebuying process and following all the required steps. Well done - and keep going.

However, there's something else that you should be doing alongside saving: making yourself look like a good bet to a mortgage lender.

#5 - Getting ‘mortgage-ready’

I’m going to start with a question: if you saw your neighbour every day, and one day she asked to borrow £1, would you lend it to her? I’m guessing you probably would. It’s only £1 and you’ll see her tomorrow.

Now imagine if a week later, your neighbour asked for £5. And then the next week, she asked to borrow £20. Would you lend it to her?  You might - but only if she paid you back each time.

But would you be so generous if your neighbour came straight up and asked for £20? What if she didn’t pay you back last time? At some point you’d either say no, or offer her less than she wants. You’d probably have a few questions before handing over the cash.

Now imagine it’s you doing the asking. You would want to give her the confidence that you’ll repay it. Finally, imagine that instead of asking for £1, you’re applying to borrow £200,000!

The reality is that you may be asking a bank or building society to lend you a significant amount of money, so you want to be as appealing to them as possible - after all it’s likely to be a long term relationship!

You’ve probably noticed by now, I love a quote, so here’s another you probably already know - “By failing to prepare, you are preparing to fail" - Benjamin Franklin. Preparation is key.  Getting mortgage-ready is something you should be doing as soon as you start saving.

So, what’s appealing to lenders? And what can you do to look your best? Broadly, you should be aware of the following areas:

• Your credit score
• Existing debt
• Your spending.
• Your job
• Your record keeping

Your credit score

Many advisers will say ‘It’s all about your credit score!’ and that’s a common belief, but it’s not strictly true. Your credit score is important and it’s something that lenders will most definitely pay attention to, but it’s not everything.

Basically, a credit score is a number that depicts your creditworthiness or the extent to which you’re considered suitable to receive financial credit.   A credit score is one of the factors a lender will use to evaluate the how likely you are to pay them back on time

The higher your score, the better you look to potential lenders. Your credit score affects:

• How many lenders might be available to you in the first place,
• How much you can borrow, and
• What interest rates and mortgage deals they will offer you.

It is affected by:

• How much unsecured debt you have
• Your Direct Debits
• Your payment history
• Any CCJs or bankruptcy
• How long your credit history is
• Whether you are on the electoral roll

So, what can you do to improve your credit score? There are a few things that everyone should do:

• Pay your bills
• Check your credit score
• Register on the electoral roll
• Build a repayment history

Pay your bills

Let’s start by looking at what a lender ideally wants from you? It’s simple really - pay them back on time, every month. So, your credit score aims demonstrate if you're likely to be good at this.

It might seem obvious but the single most important thing to do is to pay your bills on time. Any missed payments will look bad to a potential lender. You need to show you can manage your finances.

Missed or late payments will remain on your credit report for at least six years.

Know your score

The next step is to find out your score and check your credit report for its accuracy, especially any errors or omissions. If anything is incorrect, make sure you get it updated straight away.

Even having a slightly incorrect address can impact on your score!

You can get credit reports from a number of companies, some of the big names in the business are shown below and different lenders use different ones and sometime more than one -

Experian - https://www.experian.co.uk/

Equifax - https://www.equifax.co.uk/

Check My File - https://www.checkmyfile.com

Clear Score - https://www.clearscore.com/

Most offer a free version as well as premium options. So, have a search around and choose whichever grabs your fancy. They generally all do the same thing and it’ll help you get to grips with your credit score.

Welcome back Ben! Yes, it's Ben from the previous articles. He’s on track with his saving and his LISA is building up nicely.  He’s now looking at getting ‘mortgage ready’ and he’s just got his credit report, which shows 550 out of 999.

He’s shocked, it’s so low. He says he pays his mum and dad his rent money in cash on time and although he has a hefty car loan, he always pays it on time. He has no other debt and always has cash around the house.

Just picture what his credit report looks like and what a lender may see (or not see).

The electoral roll

The next thing to do is make sure that you are registered on the electoral roll. This is fairly easy to do and is a quick win. In England, Scotland and Wales, you can register to vote by post or online. In Northern Ireland, you can register by returning a completed voting registration form.

The reason this increases your credit score is simply that it means that lenders can easily confirm your name and address and they know you’re not trying to hide from a past bad debt.

Ben’s on the electoral roll, but only because his dad completed the form when it came through the post. Unfortunately, he spelt his name wrong(!), so that needs fixing for a start!

Build a repayment history

So you’re doing the basics, but what other steps can you take? This is likely to depend on your situation.

If you have a limited credit history, it would make sense to build it up. You can do this byvia several methods, such as taking out a credit card. Alternatively, as promoted by Which, you might even utilise a service like LoqBox or 118 118 Money, which are also good for repairing credit scores.

Credit cards

As a Financial Adviser, it pains me to tell someone to take on a credit card, but for some potential home buyers it may be a good idea. If you have no credit history, your credit score is likely to be lower as a lender can’t see how you might manage debt. So, using a credit card sensibly can show a lender how sensible you are.

Using a credit card sensibly means:

• Using no more than 25% of your credit limit
• Pay it off in full each month - don’t fall into the trap of making minimum payments
• Never miss a payment

The longer your payment history is, the better. So, if you have no payment history, it’s a good idea to get started as soon as possible.

A word of caution - If you don’t trust yourself with a credit card, then ignore this tip. I don’t want to create you more issues.  Similarly, if you quickly find yourself not clearing the balance each month, shred the card and focus on clearing the balance.

LoqBox

An alternative to credit cards is LoqBox, which basically is a clever piggy bank designing specifically for both saving or building a credit history. It can also be great for people who unfortunately are looking to ‘rebuild’ their credit score.

You agree a sum to save over a year and they set that much aside in a locked away account. You save your money across the year and the money is then made available to you. Sounds like a savings account, but in reality it’s set up as a 0% loan and your monthly savings are shown as repayments. It is a good way of building up your credit score without getting into debt. For some of you it may be worth investigating.

118 118 Money

This is what I would call a ‘low start’ credit card and not for everyone. It can be useful to build or rebuild your credit score. Most credit cards charge interest or fees on certain transactions, such as cash withdrawals or foreign transactions.

118 118 Money offers a low credit limit card but charges no interest or fees on transactions. Instead you pay a subscription of around £8 to £17 a month, depending on your credit limit. This is great for rebuilding a score, but beware that as your credit score improves, they offer higher limits (and bigger subscription costs) and we believe that this is the time to shop around.

Ben feels he manages his day-to-day money well, so is going to take out a credit card with the sole object of building his credit history.  He’s looking at a card that offers £1,000 of credit. He's going to use it as a fuel card and pay it back every month. He usually spends around £200-£250 a month on fuel.

He’s also saving more than the £4,000 per annum LISA allowance. He’s going to look into LoqBox as well.

Existing debt

If you have significant amounts of debt, you really need to look at clearing what you can. Focus on any high interest debt as it will be the most cost effective to clear first, freeing up money to clear other debt.

There may be debt that you don’t want to repay, such as a car loan. Whilst having a car loan can be a positive in showing you can manage debt, you have to be aware that this will reduce the amount you can borrow for a mortgage.

You should be staying out of your overdraft, especially if it is a regular event. This is because a mortgage lender may conclude that you can’t live within your means and of course it’s just another debt you’ll need to pay.

Loan defaults, missed or late payments will remain on your credit report for at least six years.

You should also look to close any old, inactive credit facilities that you no longer use.

Your spending

When you apply for the mortgage, lenders often like to see 3 to 6 months of bank statements. They are looking to assess how you manage your money and ultimately assess if you could afford the mortgage repayments. Specifically, they are assessing the following:

• Are you regularly going overdrawn?
• Are direct debits being paid regularly?
• Are you living within your means and from your own regular income?

The Bank of Mum and Dad’ (BOMAD) can help you buy a home, but not if it simply shows a lender you can’t live within your own means and need bailing out. The best way to use their help is with building up your deposit.

So when you apply, make sure your bank statements are as ‘tidy’ as they can be.  Lenders aside, it is good for you to have a good understanding of your spending habits, so you know what is affordable and comfortable for you.

If there are outgoings you could cull or reduce, now is the time to do it. Even if it means deleting certain food delivery apps from your phone.

Your job

Keep that job - I mean, if you get offered a promotion at work, take it. Congrats! However, moving to a new employer within a few months of applying for a mortgage could prove disastrous, even if it's for more money.  Lenders might tell you to come back later.

Why? It's not the change of job itself, it's the timing. Lenders are a cautious bunch and are more comfortable lending you money if you have been in your job for a decent amount of time. As a rule of thumb, 3 to 6 months would be seen as an ideal minimum. Specifically, they don’t want you to be in your probation period, when there’s a higher risk that your employer might terminate the contract.

Lenders also tend to get even more concerned if you’ve had a complete career change or decided to go out on your own. Typically for self-employed applicants they really want to see at least two years' accounts. Your income during the first two years may well be lower, which also means they are likely to lend less.  

Your record-keeping

As I have said, lenders are cautious by nature and they will not take your word for anything. This leads to them wanting a whole load of documents to prove everything. There are as follows;

• Proof of income - this may be via 3/6 months’ payslips or 2/3 years accounts or tax returns if self-employed
• Proof of address, such as a council tax bill or a utility bill
• Proof of any bonuses or commission you receive
• Last 3 to 6 months’ bank statements
• Proof of deposit availability
• Proof of ID (passport or photocard driving license)
• A gift letter if you’re getting help with your deposit, stating that the person is gifting you the money and not lending it to you

Summary

Get on top of and build your credit score, make sure that you are clearing as much of your other debt as possible, and manage your spending within your income.

We also touched on the importance of your record keeping and the impact of things as simple as changing jobs. I’ll leave you with my top picks again, but I think I’ll leave the next article for Dan to write. He’s gone through ‘Finding your home’ more than once and more recently than me, but I’ll be back soon and I’ll be reading his thoughts with interest.

Adviser Top Picks - Getting mortgage-ready

1. Be on the electoral roll - Make sure you’re registered on the electoral roll so you're easy to find.
2. Pay your bills and any loan repayments - This is the best way to show lenders you are responsible.
3. Use debt to build your credit score - Use debt with caution, try and build up a positive history of debt repayment.
4. Aim to clear your debt - Existing debt reduces your borrowing capacity. Try and minimise this and clear high interest debt first.
5. Think twice before changing jobs - Think about when you are likely to apply for a mortgage, as this may impact your borrowing ability.
6. Record keeping - Ensure you have everything that a mortgage lender will want to see.