9 Steps to Fix Your Credit to Qualify for a Mortgage
You can save yourself tens of thousands of dollars in the long run if you improve your credit score prior to applying for a mortgage. This guide provides you with what you need to focus on to improve your FICO score.
IntroductionQualifying for a mortgage can be a struggle for many hopeful homeowners. Your success depends on your current financial health and your goals relating to the mortgage. If you have bad credit, the process will take longer than someone with good credit. And a lower credit score will result in a higher interest rate once you qualify for a mortgage. The good news is most mortgage lenders have unique loans available for buyers with poor credit. But it is still worth your time to increase your credit score.
Credit repair may be necessary if you want to get the best possible interest rates. And your credit report is the overwhelming focus for all mortgage lenders. Your credit report is your canvas at the art gallery: Paint a pretty picture and the fine art enthusiasts (mortgage lenders) will try to outbid each other to own your work. Paint a sloppy work of art and nobody is going to buy it.
Know What to Focus onSome areas are more important to spend your time on than others. In the realm of credit scoring the following classifications matter most:
Payment history: 35%
Outstanding debt: 30%
Length of your credit history: 15%
Types of credit you've used: 10%
Amount of new credit/credit mix: 10%
As you can see, 65% of your credit score is your payment history and your outstanding debt. Much effort should be made to address these two significant areas. Payment history mainly involves your history for on-time payments of mortgages, credit card and student loan accounts. The so-called "revolving" loans. Very simply, the more late payments you have, the more your score will suffer. Also, more recent late payments are worse than older ones.
Outstanding debt means the percentage of available credit that you have, known as "credit ratio". See # 6 below for further discussion on credit ratio.
Length of credit history is self-explanatory. Having credit accounts for 5, 10, 15 years or longer shows that you can keep accounts paid on time, or reasonably on time over the long haul. Creditors value this. If you are newer to the credit scene, this is just something that's going to take time.
New credit is the final 10% of the equation, along with credit mix. New credit accounts are generally harmful to your credit score because they may demonstrate desperation or financial trouble. This is particularly true if you open multiple credit card or department store accounts in a short time span. New accounts also provide the temptation and ability to max out credit cards, which is not what you want to be showing. Included in the new credit classification is credit mix. Basically, there is a bonus for diversification. You want a variety of different credit accounts such as mortgages, auto loans, credit cards, department store cards and/or student loans.
Finally, older derogatory accounts are better than new derogatory accounts. The negative effect of any account decreases over time. Accordingly, you should concentrate on newer accounts because their deletion or correction will give you the biggest bump in your credit score.
Check Your Credit ReportsA credit report is somewhat confusing. There is language within your report that may sound like Greek to you. But don't let that stop you from spending some time going through your reports in detail. (I suggest reviewing all three major credit reports - Equifax, Experian and Transunion. You can obtain a free copy annually at www.annualcreditreport.com). Many times, you will find that one credit reporting agency, (a/k/a "credit bureau"), will have different information than the others. That is why obtaining all three reports is important. The free report will not include your credit score. You need to get that too. You can pay for one at www.myfico.com or obtain a free FICO simulated score at the same website. You can also obtain estimated credit scores for free from multiple websites including Credit Karma and Credit Sesame.
Initially, keep it simple by focusing first on your personal information at the top of your report. Be sure your name, current and previous addresses and employers, and social security number are accurate. You want to be sure that there is no mistaken identity or identity theft. If you are seeing multiple names and addresses that you do not recognize, this is a red flag.
Your next, and most important focus is on any derogatory accounts you have. All credit bureaus separate your negative accounts from accounts that are "paid as agreed" or older closed accounts. Check every negative account and determine if there are errors.
Some errors are worse than others. Focus is on errors that cause your score to drop, such as incorrect balances, incorrect late payments or accounts that should have dropped off. Also worth checking out are collection accounts and charged off accounts showing inaccurate dates of last payment or incorrect payment histories. In sum, anything that looks wrong is worth objecting to, either with the creditor and/or by filing a dispute as outlined below.
Public RecordsYour next goal is to review your public records contained within your credit report. The public records section principally includes judgments against you, tax liens, and bankruptcy filings. You should scrutinize this section for mistakes, particularly judgments that have been paid or resolved, yet remain on your credit report. Again, anything that looks wrong must be addressed by going to the source, (often a court or LexisNexis for judgments or the I.R.S. for tax liens), and/or by filing a dispute with the credit bureaus.
A credit "inquiry" signifies that someone pulled your credit report and reviewed it either because yA credit "inquiry" signifies that someone pulled your credit report and reviewed it either because you applied for credit or a job, or for promotional reasons to try to solicit you for goods or services. Inquiries are usually listed in chronological order at the very end of your credit report.
Credit inquiries are categorized as "hard" or "soft" inquiries. Soft inquiries include promotional requests by businesses or reviews by creditors that you already have an account with. Soft inquiries do NOT negatively impact your credit score.
Hard inquiries do impact your score, but not dramatically. Hard inquiries are often related to businesses from which you specifically requested credit. The most common are mortgages, credit applications and auto loans. If you fill out a credit application, there will be an inquiry on your credit report. The occasional inquiry is normal and will not affect someone with strong credit. The trouble with inquiries usually occurs when they are recent and numerous. The strategy is to spread out your credit applications to avoid losing credit score points. Moreover, hard inquiries will hurt someone with poor or limited credit more than someone with a long history of established credit.
In terms of credit repair, review all inquiries to determine if each and every hard inquiry is accurate and represents a specific request for credit by you. If you cannot identify or recall a listed hard inquiry, contact the creditor or business directly to find out if it is legitimate and to object to it if necessary. The name and contact information for each inquiry is clearly listed on your credit report. Inquiries may also be disputed just like inaccurate accounts.
Dispute Inaccurate Accounts, Public Records, and InquiriesUse the "what, why, show, certify" method to dispute any inaccuracies in your credit report. I authored a legal guide explaining the process in detail that you can find here: https://www.avvo.com/legal-guides/ugc/the-correct-way-to-dispute-your-credit-4-easy-steps
You are writing dispute letters to the credit bureaus, NOT your creditors. (However, as noted, you should also go to the source and request correction directly). In each letter, identify "what" account is not accurate. Explain "why" it is not accurate. "Show" them why it is not accurate by enclosing documentation such as bank statements showing payments made on time. (The credit bureaus literally won't look at any of your documentation. You enclosing this proof just in case you need to file an FCRA lawsuit at some later date). And finally, send the letters by certified mail.
Keep copies of all letters and documentation you send. This is important to provide to your attorney if legal action is later necessary. If the credit bureaus cannot verify the information or accounts that you dispute, they must be removed. And they generally have only 30 days to respond to your letter(s). Be sure to keep every response that you receive from the credit bureaus.
Consider Hiring an Ethical and Legal Credit Repair ProfessionalIf you have multiple derogatory accounts, you may need some help. Hiring a professional to assist you with credit repair can be difficult. Frankly, there are a lot of unscrupulous and unqualified credit repair professionals, (CRP's), out there. CRP's, are governed by the Credit Repair Organizations Act, (CROA), which is a law that protects consumers against the illegal behavior of CRP's. Some things to avoid when looking for a legal and ethical CRP:
1. Guaranteeing the removal of negative credit listings
2. Charging you up front, before services are performed
3. Creating a new credit file that is not actually yours
All the above is unlawful. Moreover, a CRP is required to provide a written contract for services that permits you to cancel within three days of signing the contract. The best way to find a legitimate CRP is to get a reference from friends or family. And be sure they comply with the CROA. If you choose to hire a CRP, I also urge you to utilize the services of a CRP with offices in your State if possible.
Resolve Unpaid or Late AccountsAccurate accounts that are derogatory need to be resolved. Only begin to pay down or pay off accounts AFTER you initially attempt to clean up your credit report as outlined in step 5 or 5b. The rationale here is to not pay off an account that might just disappear with some consistent credit repair work. Begin making consistent payments on accounts that were periodically or consistently late.
Reduce Your Credit RatioCredit ratio is the amount of credit you have available in relation to how much you are using. If you have a credit card with a limit of $10,000, and you have a balance on that card of $4,000, your credit ratio is 40% for that card. Now if you expand this example across all of your accounts, (e.g. mortgage, credit cards, lines of credit), you can figure out your total credit ratio. The bottom line is that you want your credit ratio as low as possible. The lower it is, the more your credit score will benefit. I tell clients to get it below 20%, but ideally you should try to work your way to zero, having no balances whatsoever and paying off bills to zero every month.
Reducing your credit ratio is manageable. One strategy is to simply increase your credit card limits. Some creditors will allow you to do this, depending, (of course), on your payment history and overall credit health. Other creditors will ask for a fee to increase your limit, and some won't let you do it. The obvious problem with this method is that you will have more room to overspend with that higher credit limit. Those who tend to binge shop or have trouble budgeting should not try this. Simply paying down your credit cards over time or making multiple monthly payments is a good way to reduce your ratio for those who have the ability to do so.
Don't Open any New AccountsPart of any plan to reduce credit ratio and improve your score must include financial responsibility and self-discipline. Needless to say, maxing out credit cards or opening new department store or other accounts is damaging.
Rapid RescoreThis is an advanced strategy dispute that your mortgage broker may or may not be willing or able to attempt. Rapid rescore is a lightning quick dispute, that could take as little as three days to achieve. And it doesn't always work.
Essentially, if you are down to the wire and you need one or two accounts to be corrected to get approved for a mortgage, rapid rescore is an option. it is something you should ask your mortgage professional about if you have little time to go through the normal dispute process, which can take months. This process involves your broker submitting disputes to "resellers", or smaller credit bureaus that report to Equifax, Experian and Transunion. These resellers then send your dispute directly to the main bureaus for instant reinvestigation. It may cost you up to $50 per account but it is well worth the money to potentially get you approved or get you a better interest rate.
ConclusionLenders will look at a variety of personal information, including your income, length of employment and whether you had a prior mortgage, to determine your eligibility for a new loan. And your mortgage professional is also a factor. Sometimes mortgage brokers have connections with certain lenders that can help you get in the door.
But more than any other factor, obtaining a mortgage is directly connected to your credit score. Generally speaking, you want a credit score over 700 to obtain a mortgage at a desirable rate. 760 or above should get you the very best rates. Consumers can absolutely achieve the dream of home ownership with lower credit scores, but it comes at a high cost. If you don't qualify for a highly desirable rate initially, you can keep working on your credit and seek a refinance at a lower rate, usually within a year.