One of the biggest stumbling blocks in buying a home or refinancing is often having a lower credit score. In our experience, there are three main reasons for a less-than-perfect credit score:
- Late Payments: If you have a late payment on your credit, it does not bode well for a lender to whom you will be making payments for the next 10-30 years. Usually, if it’s just one late payment, you can sometimes get it removed from your credit report, but if you have more than one, it’s unlikely that the creditor would be willing to remove it. The more recent and the more severe the late payment, the more of an effect it has on your score. If you are currently past due (30 days or more) when your credit is checked, that can bring down your score by as much as 75 points.
- Credit Limit Usage: Frequently, we will see credit cards maxed out, or nearly. Sometimes they’re even over the limit. As a general rule, you should always try to keep your credit card balance no higher than 50% usage (though 25% is even better). If paying down the balances to 50% is not an option, at least assure that they are under the credit limit. We can actually run a simulator that will tell us which cards need to be paid down and by how much to achieve the target credit score.
- Medical Collection Accounts: The medical billing system in the United States is maddening. Sometimes you won’t ever receive a bill, and your account will go immediately to collections. The good news is that these types of collections accounts can usually be removed from your credit report (though you will probably still need to pay them off). Often, the collection agencies will even accept a settlement (letting you pay less than they say you owe).
There are also a few misconceptions that we commonly hear regarding credit scores. These include:
- “Checking my credit hurts it”: This is true if you are obsessively checking your credit over a range of credit types (car loans, department stores, etc.), because it makes you appear desperate. But getting your credit checked by several different lenders while you’re shopping around for a mortgage is not going to hurt your score. Also keep in mind that unless you get an actual FICO score from a real credit reporting agency, it is probably not a valid score and can’t be counted on.
- “I should pay off my collections accounts”: The simplified reason for this is that while it may help in the long-term, paying off collections actually hurts in the short term. Why? Because as soon as a payment is made to an account, even a collections account, that account is “refreshed” on your credit score and becomes current. In essence, it would then be as though it were a new credit collection account, which carries much more weight than an older one, regardless of the balance. In these situations, the best way to deal with a collections account is to get it removed, which usually involves negotiating with the collection agency.
- “I should pay off and close my accounts”: If you have a good, long-standing credit account to which you have made regular payments, closing this account will take it off of your credit report. You want these kinds of accounts to show up because they prove you have established good credit. So go ahead and pay down or even off your accounts, but be careful about which ones you have removed (if any). Having no credit is bad credit.
So what else can you do to make sure you have a healthy credit score when it comes time to take out a mortgage?
- Keep track of what you owe. Having a record of all your accounts, including your mortgage, auto loans, student loans, utilities, credit cards, medical bills, etc, will be helpful. Update your records every time you make a payment.
- Pay your bills, and pay on time. As mentioned above, a late payment can be a serious hit to your credit score. Always pay your bills on time, negotiating with your creditors if it is absolutely not possible. You might also come up with a payment plan for yourself to pay off debts such as credit cards and student loans (if you consistently pay with minimum payments, you could end up paying a lot more in interest, so it could be good for you to pay more than that).
- Protect your identity. It’s amazing how many people don’t realize they should shred or otherwise destroy (burning is just as fun!) sensitive documents. It’s easy for identity thieves to pick up personal information from documents (or even credit card offers) that are simply thrown in the garbage instead of destroyed. Delete suspicious emails (without opening them) and be careful with your wallet/purse.
- Keep track of your charges. Check bank and credit card statements at the end of every month or so. Make sure every charge on there is one you remember or have accounted for. This will help keep you on top of your accounts, keep you from going over your credit limit, and it will be easy to see if there’s a mysterious charge.
If you already have bad credit, what can you do?
- Remember that certain items stay on your credit longer. Inquiries stay on for 2 years, delinquencies for 7 years, and public record items for 7-10 years. Maybe you only need to wait a bit longer for something to go off your credit report, or at least until it gets old enough that it doesn’t have much of an effect.
- Give it time. If you know it’s going to be another year or so before that bankruptcy no longer matters, use the extra time to save up more for a down-payment (or to pay off other debt). Being able to put up a larger down payment when it comes time for a mortgage will significantly help your rate/terms.
- Consider using only your spouse’s score. Your score only matters if your name is going to be on the mortgage. If you have a poor credit score, but your spouse’s is just fine, consider letting the mortgage be only in his/her name. Later on down the line, you might be able to refinance when your score is better, and put yourself on the loan at that time. You can still be on the title without being on the actual mortgage. Understand, though, that if your credit isn’t used, your income can’t be considered either.
- “Alt-A” Options are Available. Mortgage options for credit-challenged borrowers are coming back (and these ones are legitimate!). In some cases, you can even get a mortgage just 1 day out of bankruptcy. The rates are higher and they are more stringent on other areas (like income and down payment), but those options may be best for some.
- Keep on top of things. Aside from the tips already listed above, you can periodically check your own credit score. You are entitled to one free credit report from each of the big three reporting companies each year. Annualcreditreport.com is a legitimate website that deals with getting these free reports. You can stagger ordering from each company, say every four months or so, and get an updated report for free throughout the year.
Ultimately, an experienced mortgage professional will be able to determine what your options are now, what they could be in the future, and will be able to help you put together a plan to accomplish your financing goals. We’ve helped many clients who were certain they had no options, so let us see what we can do!
