Mortgages

How to Keep Bad Credit From Killing Your Mortgage

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The credit and financial choices you make today can shape your chances of getting a mortgage in the future. If you have a tarnished credit history, you still may be able to qualify but it will be a document-heavy process.

A mortgage is the largest form of credit a consumer can obtain, so be prepared to prove yourself credit-worthy. Your credit history is important because it not only informs your credit score, but it also provides further insight into how you have, use and maintain your credit obligations.

Lenders will give consumers’ credit a closer look if their history shows a greater possibility that they might not make a mortgage payment on time.

So when you go to buy a house, be prepared for these little lending nuances that may arise if you have an inconsistent credit history.

If You Have a Lower Credit Score

Your payment history is the biggest factor in your credit score, so an unsatisfactory payment history can lead to a lower credit score, possibly resulting in a score less than 660. Conversely, if you pay your loans on time, or as agreed, you’ll tend to have a higher credit score.

Usually a combination of factors lead to a score in the 620-659 range, such as high credit card balances, closed credit cards, a charged-off account or collections with old balances, or little credit as whole. Borrowers with credit scores in this range will have to provide explanations to the lender regarding negative items on their credit history, such as any possible collection accounts, charged-off accounts or delinquencies.

If you have a score within the 620-659 range, you can expect to pay more for a conventional fixed-rate loan. (It can get even pricier if you have little equity to offer, in the realm of less than 10% down.) It would not be unreasonable for a borrower to pay as much as o.375% higher in rate than someone with good credit and a higher down payment. That may seem like a small amount, but it can translate into thousands of dollars over the life of the loan.

If You Don’t Pass Automated Underwriting

All mortgage lenders selling loans to Fannie Mae and Freddie Mac use what’s called “automated underwriting” on each loan application.

When you submit an application for a mortgage, the lender will run an automated underwriting system analysis on your credit, debt, income and assets. Effectively, automated underwriting is an algorithm that comprehensively reviews the borrower’s total financial picture. If automated underwriting results show anything other than “approve eligible” or “accept accept,” you may not qualify without making some adjustments. These adjustments could include increasing your down payment, showing more savings in the bank, procuring a co-signer, changing your loan program (to an FHA loan, for example) or loan term, and taking time to clean up your credit history.

If You Need to Clean Up Your Credit

If you fail the automated underwriting analysis, there are things you can do to improve your credit profile, but you may need to take some time to do it.  These steps may not necessarily be quick fixes, depending on your circumstances, but they are worth it.

  • Pay down your credit card balances to 30% of the total credit line on all credit cards. For example, if you have a credit card with a credit limit of $1,000, you don’t want the balance to exceed $300.
  • If possible, pay off in full all credit card balances, but do not close the credit cards. Closing your credit cards can lower your credit score by lowering your available credit, giving you a potentially higher utilization ratio when you do carry a balance. It will also eventually lower your score by reducing the average age of your credit history when the accounts “age” off your credit reports in 10 years.
  • Prior to applying for a mortgage, you can attempt to deal with old collection accounts by settling the balance, and trying to get the account removed from the credit report entirely — as though the account was never there. Negotiating a settlement with a creditor after applying for the mortgage is different, meaning the borrower would have to zero out the account if the old credit account has a balance exceeding $2,000. Keep in mind, however, that it may not be easy to remove a collection account (this is why) – even if it’s paid – from your credit report. Collection accounts on your credit report, paid or not, will lower your credit score. (The one exception is VantageScore 3.0, which excludes paid collection accounts.)

If you plan on getting a mortgage and know you have some credit challenges, it’s a wise decision to first take the time to bolster your financial picture at the advice of a qualified lender. When it comes to improving credit, it isn’t always intuitive. However, there are services out there that can help you determine the best course of action for your situation.  Credit.com, for example, shows you two credit scores, plus an analysis of your credit and a personalized action plan to meet your goals, all for free. Having a road map can help you make better decisions along the way, which can help you save money in the long run.

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