credit

Getting Credit Ready for Taking Out a Mortgage Home Loan

Credit scores affect pricing and programs when getting a home loan

A lender will typically look at the middle of the three scores that come from the three credit reporting bureaus, Equifax, Transunion, and Experian. If there is more than one borrower then they will use the lower of the two middle scores or if there are only two scores, the lower of the two. This score is used in the pricing engine to determine rates and also will determine what programs are available to a potential borrower. Scores can go as high as 800. The standard benchmarks for good credit fall into the 680-720 range. Below 680 some programs cease to be available and below 620 it is reduced further. The higher the score the more options you have for loan programs and better rates.

The good news is that FHA loans and a few other odd programs will go down as low as 500. It isn’t guaranteed, but you have a chance. Generally speaking your best shot at great rates and choices is with a score of 680 or better. The other good news is that you can improve your score over time if you pay your bills on time regularly, use credit moderately, and keep balances down or at zero. What is a 500 could today, could be far higher in a matter of months or a year or two. You aren’t stuck there forever.

Credit clean up isn’t hard, though it can be a little time consuming. There are a number of credit clean up agencies out there or you can do a program like Financial Peace University that will help you make a budget you can live with. Even if you have had a bankruptcy, vehicle repossession, charge offs or collections, with some pro-active steps to resolve each of them, one at a time and some time to pass it will improve. Many people go through phases in their lives when they are financially messy but are able to conquer the problems, develop good habits, and go on to high scores and a better financial life.

Depth of credit and length of time with tradelines matter when getting a home loan

A mortgage lender will typically look at the most recent 24 months for credit history, along with the score, to get a better understanding of where a borrower is financially and how responsible they are with credit. If there are extenuating circumstances such as an illness, ill family member, divorce, failure of a business, job loss, these things can be explained as part of the credit file. If the most recent 24 months is clean the scores will also reflect this. The harder part is if a person has never taken out or had to manage credit before and the only things that happen to show are derogatory trades like a medical collection or a landlord that reported them late, this makes for a report with low or no scores.

To solve this, it is best to go to your bank and set up an account where you borrower against funds that the bank holds – they usually start with $500 and then give you a credit card for $500. You can’t take that money out because it is collateral for the card, but you can borrower on the card and then pay it back every month. After a time they will have a rating on the account and you will slowly become eligible for an unsecured line. Department stores and retailers often offer cards. These are also a good way to start credit as they will give you a history. Most important is that if you use the card – pay if off right away.

Usually a lender will be looking for each borrower to have at least 3 tradelines for at least 24 months. This will also usually produce a viable credit score with all three credit bureaus. The bummer is that if you are a renter, rent may not show up on your record. This seems a bit crazy since for most people, that is the largest bill they pay. You can go to a number of services now that will set up your rent payments to be reported on your credit. This has been known to boost scores by 20-60 points very quickly if rent is paid and reported as on time. If you are paying on time and doing credit clean up – do this first to give yourself a jump start in the right direction.

How a lender sees your credit

Underwriters and investors are really in the business of risk management. The markets have taught them that loans with higher scores, more money down (skin in the deal), and stable income are better risks and more likely to make timely payments than borrowers where the scores are low, the derogatory marks on the credit are many, employment is erratic and cash saved is slim. If your score is higher, you are proving to the lender that you are low risk borrower and therefore get the perks. Use this as an incentive if you have to do credit cleanup. You want to become the lowest risk possible for a potential lender and good to your signed promise for paying back the funds you borrow to get a home.

Summary of ideas for raising your score and cleaning up your credit

  1. Get copies of your free credit reports from Experian, Equifax and Transunion – review them. They will each be a little different from one another. Make sure everything on there is yours, is accurate. If you see errors, follow their reporting policy and let them know the error. Send whatever documentation you need to prove it. They will mark it in dispute and have to research and rectify it in 30 days or less.
  2. No credit? Go get some. Do a savings secured card with your bank or credit union. Have someone cosign on a card with you. Search for the service that signs you up for having your utilities reported on your report. Get started with at least three trades. Take up an offer with a retailer you shop at regularly. Pay them off every month and avoid carrying a balance so you don’t get behind.
  3. If you are paying rent, sign up for one of the services that monitor rent payments. This will be one that builds credit quickly
  4. Got collections? Whatever you do on these – do it to all of them at the same time. The reason is that for some reason, even when you pay on a collection every time they do something on it – even if it is reducing a balance, it will hit your score with a drop because it treats it like a new collection. Unfair, but a bugaboo to watch out for. When you have funds to pay the collections all off, call them. Try to negotiate a deal: 1) take less for the amount they say is due 2) remove it as showing as a collection 3) get your deal in writing with a manager’s signature 4) pay the agreed amount promptly and make sure you have a receipt like a canceled check. Submit all copies to the bureaus that are reporting the collection and ask them to remove the collection. You might get lucky and have them removed altogether and if not, it’s just a time waiting game. One other word of note here. If you have collections and your score is OK and you want to get rid of them but you are in the middle of your loan process – pay them at or after closing so as to not let your score have a hit.
  5. Simmer for 24 months after establishing new lines, fixing credit issues or getting beyond other derogatory tradelines. If you pay regularly, it will only get better. In the meantime you can save money, take an extra job if you are able and build up what you need for your purchase.
  6. Sign up for a service – many are free, like Credit Karma, that monitor your scores. You can watch it rise and feel the reward of a job well done in progress.
  7. Remove old partners. If you are a joint owner with someone on a card that isn’t in your life anymore, like a former significant other, go get yourself off of that trade or get them off – whatever it takes.
  8. What about a bankruptcy? These happen. The typical waiting period on these is four years, though there are some exceptions. While it depends on the specific circumstances the standard waiting time on a Chapter 7 or Chapter 11 is two years from the discharge or dismissal date. From a Chapter 13 it is also the same, however, in some situations this can be as long as 3-5 years from the discharge date. It is also possible in some situations if you are in the middle of paying on a Chapter 13 Wage earner bankruptcy that a home may be purchased in that time.
  9. Pay down balances. If you have trades that are maxed out, pay them down to 1/3 of the total available line. This makes the ratio of your available credit to amount owed lower. Sometimes opening a new tradeline and transferring part of the balance to that one can accomplish the same thing.

Credit scores change based on habits. It’s never too late to develop and hone good ones.

Kristin M Eklund NMLS #1872091
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