Let’s face it. We all make mistakes. Some are more serious than others, and some can havelasting effects.
Messing up your credit history is one of those.
What do we mean? Well, even if you were careless with credit in the past, you can make amends now. But it takes time so if you’re in the market for a new home and your credit score is less than what it takes to qualify to buy one, you need to get started on correcting things sooner rather than later.
First things first
If you’ve made late payments in the past, or are currently doing so, stop! Making late payments is a sure fire way to lower your credit score. The farther in the past the late payment occurred, the less effect it has on your credit and your credit score. So get started right away paying your bills on time, or even better, in advance.
Once you’ve got your bill paying in order, clean up any delinquent accounts. While they do remain on your credit report, paying off unpaid bills will still help your score. That’s because unpaid, charged-off debt is far worse than a late payment. Again, the greater the length of time between your late payment(s) and your current good bill payment history, the less impact your late payments have on your score. Keep in mind, any tax liens or judgements against you that haven’t been satisfied will likely stop any loan application in its tracks.
Of course we would be remiss if we didn’t advise you to get a copy of your credit report and check it for any errors. There might be payments that are incorrectly recorded as being late. Or unsettled debt that is not yours. You are entitled to one free copy every year from each of the three leading Credit Reporting Agencies (CRA): Experian, Equifax and TransUnion. Our suggestion is to request a different report every four months and review each carefully. If you are in the market for a home, you might consider pulling all three at once since they often contain slightly different information, and each could have a different error that needs to be corrected.
Should you find errors, you can write individually to each of the three CRAs and tell them there are mistakes. Of course, that can be time consuming and confusing. You can also hire a reputable credit repair organization to do this for you for a fee, but be sure to do your research first. CRAs have 30 days to investigate the creditor in question to have them verify the accuracy of the information they furnished. If the creditor doesn’t respond, or if they confirm your challenge of the data they shared with the CRA, the CRA will remove the info from your report.
Another reason to check your credit report is to ensure that any negative information, other than bankruptcy, is removed after seven years (bankruptcies are removed after ten years). The CRAs are required by law to do so.
Lower your debt
Another item which banks and other lenders scrutinize when assessing your mortgage application is your debt-to-income (DTI) ratio. That’s because they want to be sure you can pay them back and that you aren’t over extending yourself.
DTI measures the amount of income you have against the amount of debt you owe. To arrive at your DTI, divide your total monthly debt by your total gross (before tax) monthly income. For example, if you have $1,000 in monthly debt, and $3,000 in income, your DTI would be 33.3% (1,000 divided by 3,000 = 33.3%). The DTI threshold for lenders generally falls between 38 and 42%. If your DTI is at or above that range, you probably won’t be getting a loan.
To qualify for a loan, you will need to reduce your debt and corresponding monthly payments as much as and as soon as possible. Paying the minimum balance probably won’t do. Find a way to reduce expenses and ramp up payments. Most lenders consider 16-19% a moderate debt ratio. Your ability to borrow may be limited if your ratio is 20% or above.
The four key steps
In summary, here are four key steps when preparing to buy a home with a history of bad credit:
- Pay your current bills on time (or even better in advance)
- Pay off any delinquent accounts
- Check your credit reports and if there are errors, get them corrected
- Keep your debt ratio down, preferably below 20%