Mistakes or legitimate negative marks on your credit report will cost you big when you get a mortgage – assuming your credit problems do not keep you from getting a home loan entirely. Fortunately, it is never too late to become credit worthy, but it will not happen overnight. It is best to begin repairing your credit at least six months before you plan to apply for a mortgage, but some steps can boost your credit score in as little as one month.
Order Your Credit Report
The first step to credit repair is ordering your credit reports from the three major bureaus: Equifax, Experian and TransUnion. Each report will most likely be a little different, as creditors are not obligated to report to all three bureaus, and most typically report to the one bureau to which they subscribe.
You can order a copy of each credit report for free once every 12 months through AnnualCreditReport.com. Be sure to type this address into your browser, as there are several websites with similar names that will attempt to charge you for the report. You are also entitled to a free copy of your report if you have been denied insurance, employment or credit because of the report.
Examine Your Reports for Mistakes and Problems
Almost all consumers have at least one mistake on one credit report. This is because credit bureaus generate your report using information received from your creditors, which is not verified. If you have a common name, the chances of finding a collection account or public record that does not belong to you is increased.
Carefully check all aspects of your credit report for typing mistakes, outdated or incomplete information, inaccurate account histories or anything that does not belong to you. Be prepared to dispute any incorrect information and explain why the information is incorrect.
Negative information that is correct and true can only be improved with time and improved credit habits. Late payments and charged-off accounts will remain on your credit report for seven years, while a bankruptcy will remain for ten years.
The good news is most lenders are looking for a pattern of payment and will not focus on a single late payment, as long as it was not recent.
Pay Delinquent Accounts
It is important to pay off any delinquent accounts, including judgments, charge-offs and collections, prior to submitting a mortgage application, because lenders will want to see that you not only make your payments on time but honor your commitments. Unpaid collections are always worse than paid collections. If you can negotiate a pay-off settlement with creditors to reduce your bill, do so, but demand that derogatory remarks be removed from your credit report or reported as paid in full, and get this in writing before sending your payment. All accounts should be brought current before submitting your application.
Reduce Your Debt-to-Income Ratio (DTI)
Your mortgage underwriter will question your ability to make the monthly mortgage payments if you have a high amount of debt compared to your income. If your DTI is too high, your lender will most likely not approve a mortgage at all. Bring your monthly payments down to no more than 12% of your income, if possible. After factoring in your new monthly mortgage payment, your total debt-to-income ratio should be no higher than 43%.
Improve Your Payment History
If you begin working on your credit soon enough, you will have time to lessen the impact of past late payments with a new history of on-time payments. The older the late payments and derogatory marks on your credit, the less impact they have on your credit score and ability to qualify for a mortgage.
Do Not Incur New Debt
If it will be some time before you apply for a mortgage, it can make sense to establish new credit accounts to add stability to your credit report. If you are going to apply within the next few months, avoid incurring any new debt, and in some cases even opening new credit accounts, as it will look suspicious to a lender. Stay away from any new credit transactions until you obtain your mortgage and the purchase of your home closes.
Rapid rescoring is a practice used by mortgage brokers and lenders to help a borrower's credit score improve enough to receive a better mortgage. Using rapid rescoring, new information may be added to your credit file in just a few days, rather than the weeks or months it can take a credit bureau to do its own.
In the 2012 mortgage climate, raising a borrower's middle FICO score from 699 to 720 would save 1.25% in fees. The cost for rapid rescoring is fairly small compared to the improvement in mortgage pricing. If you're in a tight lending environment, every point counts, particularly if you have average credit and want to take advantage of low rates.
Rapid rescoring is basically an unofficial way of updating the credit report to get errors corrected much faster than simply filing a dispute with the credit bureau. A lender or broker providing rapid rescoring will have the errors corrected by contacting the bureau directly and providing proof to have the credit score recalculated. Rapid rescoring is also useful if you want to pay down high credit card balances and need to add a small number of points to your score.
Warning: Beware of Credit Repair Companies
Beware of credit repair companies who will promise, illegally, to remove accurate negative information from your credit report. Some of these companies will claim they can remove bankruptcies and liens, or even create a new credit identity. These are common claims of shady credit repair organizations (CROs) which usually cannot deliver on their promises. Consumers may end up paying hundreds or thousands in fees, only to end up with more debt and a credit score that is actually lower.
Keep in mind no one can legally remove accurate negative information from your credit file. Credit bureaus are also obligated to update or delete inaccurate or unverifiable information, but not accurate information unless it is more than 7-10 years old.