Ultimate Guide to Credit and Getting a Mortgage
These are income, assets and credit.
Credit more than ever is an integral part of how lenders see your overall profile when you apply for a home mortgage. Let’s go over what you need to know to increase the likelihood that you'll qualify for a mortgage from a credit perspective. Whether you apply to purchase a home or refinance your existing mortgage.
In this article we’ll cover:[list style="note"]
- What a Credit Score is and How it’s Calculated
- The Greatest Influences on Your Credit Score
- How to Build a Credit History Even if You Don’t have a Score
- How to Raise Your Credit Score
- The 7 Year Myth
- How to Fix Errors on Your Credit Report[/list]
What is a Credit Score?
When you hear the term credit score, this refers to the number that each of the three credit bureaus, those being Trans Union, Experian and Equifax have given to you. Each of these bureaus use a slightly different algorithm to determine your score.
So who exactly are these credit bureaus?
They are agencies that collect data from creditors, such as credit card companies, auto loan companies, banks, mortgage lenders and public records. Once they get this data they run it through scoring models which calculate a credit score. Then, when agencies such as mortgage lenders are in the process of making a decision as to the creditworthiness of a potential borrower, they go to the bureaus for information.
Each of the three bureaus provides one credit score. The lender will then take the middle of the three scores and use that as “the” credit score in making their decision.
These credit scores range from 350 to 850 - the higher the better.
In theory, it may seem as though all of the bureaus will receive the same information from the same creditors at the same time, making all three scores the same. In reality different information will arrive at the bureaus at different times, so scores will differ from bureau to bureau.
Some creditors only report to one or two of the bureaus, this can also make the three scores quite different. Some creditors report on only even or odd months and they may stagger these months between bureaus, this can also make the three numbers different.
To account for this, lenders will use the middle of the three scores.
Greatest Influences on Your Credit Score
Your credit score is like a snapshot of how you manage your credit, both now, and how you have in the past. There are many factors that compose a credit score, and all have different weights when calculating a score.
There are several factors that will have a greater impact on your scores than some of the others. These are balance to limit ratios, recent late payments and depth of credit history.
Balance to Limit Ration
Ideally, when you apply for a mortgage, you will have one or two credit card accounts. If these accounts have a balance that is close to, or over the limit. This tells lenders that you are possibly overextended with the credit you have available to you now, and may not be a good candidate for additional credit. If you are able to pay these down, before you apply for a mortgage, this will help your cause.
[note color="#fbf7b2"]If these accounts have been open for a while, you do not want to close these accounts. You want to leave them open with a smaller balance. A good rule of thumb would be to keep the balance at or below 33% of the credit limit. Having credit available to you that you have not chosen to use, is a very good sign to the lender.[/note]
Recent Late Payments
A late payment is a payment that was received by the creditor more than 30 days beyond the due date. If you made a payment beyond the grace period of 15 days, this is not a 30 day late and should not be reported on your credit report.
Recent late payments are another source of review for lenders when you apply for a mortgage. If you’re having issues keeping up with your current obligations, you may not need to take on any more debt than you currently have.
There are of course life changing events, such as those that can render a person unable to work for an extended period of time. During these times, bills may fall behind and some of this can be explained away to lenders in a letter of explanation.
Over time these late payments will have less and less effect on your credit score. Where the challenges come in is when you are habitually late, and are unable to explain the cause of it.
Depth of Credit History
The longer you have shown the reporting agencies that you have been able to manage you monthly obligations, the better your score will be.
A deep and clean credit history is very valuable.
[note color="#fbf7b2"]If you’re only 25 years old and you’re reading this article, this may sound great but not necessarily be of much value.
However there are things you can do to beef up your depth of credit history.
You can ask one of your parents if they have had a credit card open for a period of years. If they have, they can add you as an authorized user to the account and a card will be issued in your name.
Of course, you don’t want to actually use that card. But, in many cases the credit report will show the entire history of the account on your report and this can help your score. This doesn’t always work but it can in some cases.[/note]
FHA is the most common program used by first time home buyers. The relaxed credit standards and low down-payment requirements (only 3.5%) are very attractive to young families. FHA mortgages also carry very low fixed interest rates.
If you lack credit history simply because you have never used credit cards and have always paid cash for your cars, FHA does allow for “alternative trade lines”.
A “trade line” is essentially a current or past account on your report.
While FHA would prefer to see a good history and credit score, you do have an option if this isn’t the case.
[note color="#f4f66f"]If you have an account that with a vendor that you pay each month, you can get a letter from that vendor and supply cancelled checks showing that you have paid on time for the previous 12 consecutive months.
The same applies for a cell phone account. A cell phone only reports to the bureaus if you stop paying. But, if you can supply proof that you have made that payment on time for the last 12 consecutive months, this can be an alternative trade line.
Utility bills like electric, home phone or even cable and internet can work as well.
The best alternative trade line would always be something housing related like rent payments. If you are building an alternative credit history, always pay your rent on time and by check. This way you can build a chain of cancelled checks verifying you have paid on time.[/note]
The 7 Year Myth
It is widely believed that any negative marks on your credit report will automatically drop off after 7 years. This just isn’t true. If you’re waiting for this magical 7 year date to come before you apply for a mortgage, you will be disappointed.
What you really want to do is contact a mortgage lender and have your credit report pulled so you can be proactive and not be disappointed by a big surprise.
A mortgage professional can make very valuable suggestions on what you can do to raise your score and raise it pretty quickly.
Documentation is the Key
If you have a negative mark on your report that you just know is an error, then you want to be proactive and helpful so your mortgage professional can help you get rid of it.
You can’t just say “That’s wrong!” and assume that the conviction in your voice will make it all go away. Think of it like you are going to court to state your case and in order to win in court…you need evidence.
In this case the evidence would be:[list style="check"]
- Cancelled checks showing the payment was made on time.
- A letter from the creditor stating that there was an error on a specific account number and on a specific date.
- A bank statement showing all payments made by auto-draft on time.
- Any other documented evidence that you can bring in to show that the error is just that, an error.[/list]
If you can supply documented proof that the report is wrong, then your loan officer can help you via their reporting service. If you can’t supply evidence, no amount of angry denial will get the job done!
Team work is key and we're here to help you, we're on your side!
How Bankruptcy Impacts Your Credit Score
A bankruptcy in your past does not exclude you from mortgage financing.
Some programs require 12 months have past before you apply and some require 24 months. A clean and well managed bankruptcy will help your credit score recover quite quickly. In order to recover your credit score after bankruptcy two things need to happen.
1) Your bankruptcy must be handled professionally by a highly qualified Bankruptcy Lawyer. Leaving loose ends and outstanding filing requirements will hinder the recovery of your credit score. Always hire a lawyer that focuses on bankruptcy law and always respond to their requests quickly.
2) The most important factor in recovering from bankruptcy and applying for a mortgage is your post bankruptcy credit history. Having a clean history post bankruptcy is not only vital, it is required. Your lender will always look at the history after the bankruptcy to be sure that there have been no late payments or credit abuses.
We have seen credit scores recover into the 700's within one year after bankruptcy if the process is handled properly and the history is clean after the filing.
Here are more valuable First Time Home Buyer Resources.
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