A lender will review your credit history in an effort to determine how you have used credit in the past and how you have generally regarded your credit reputation. How you have regarded your credit in the past provides a good indication of how you will pay your debts in the future. If you have paid late or not at all in the recent past then you are perceived as a higher risk, are charged a higher interest rate, required to have a larger down payment, or both, or possibly denied altogether. Your credit is a very important factor in the mortgage approval process and your lender will require that you sign a document giving them permission to review your credit report.
What is Credit History and a Credit Report?
If you have ever taken out a consumer loan for the purchase of a vehicle or furniture, used student loans for college, or have ever had a credit or charge card then you probably have a credit history. How you paid on those credit accounts was probably reported to one or all of the nation’s three main credit reporting agencies or credit bureaus: Equifax, Experian, and Trans Union. Each of the three credit bureaus collects data from your creditors, stores it in your credit file, and then sells it to your future creditors, insurers, or employers in the form of a credit report. The credit report provides information regarding any credit transaction that has occurred in the past 7-years, previous addresses, previous employers, as well as any alias names you may have used. In the case of public records such as bankruptcy or tax liens the information can be reported for up to 10-years.
Each of the three credit bureaus maintains different information about your past and current credit. Therefore, mortgage lenders require a credit report that combines the information from all three credit bureaus into one report called a merged in-file. This three bureau merged credit report provides the most complete listing of your credit history.
"No Credit" is Just as Bad as "Bad Credit"
To qualify for a conventional loan you must have an established traditional credit history. That is you must have a credit file with the three credit bureaus containing information regarding your payment history. Conventional lenders want documented evidence of your ability to repay a loan according to the payment terms and if you do not have a credit history, with one or all of the three credit bureaus, then you are almost guaranteed of being denied for a conventional loan.
Government loans such as FHA, VA or RDA aren’t as strict and allow those people who do not have traditional credit references to use alternative credit references. An example of an alternative credit reference would be your local telephone company. The phone company allows you to use their service and agrees to bill you later for the charges. This is substantially the same as any other form of credit…buy now and pay later. The main difference between an alternative credit reference and traditional credit reference is whether they report your payment history to the credit bureaus in a consistent and timely manner. A traditional credit reference such as a bank or credit card reports your progress monthly to the credit bureaus. The phone company does not report consistently to the credit bureaus….but certainly will if you don’t pay your bill and they have to place your account for collection. If you are applying for a government loan and do not have traditional credit references you will be asked to contact your phone and other utility companies to obtain a letter of reference regarding your payments. The phone company and other utility companies get requests for these letters all the time and have a letter in their system already prepared for this purpose. The letter will indicate whether you have paid on time, whether they have sent late payment notices or have disconnected your service. Just like any other form of credit, how you have paid in the recent past provides a good indication of how you will pay your debts in the future and your lender will be looking for a good payment history.
Feel Like a Number?
Remember the line from that song…”I feel like a number”. Well, that’s exactly what you are to the three credit bureaus. You see, the three credit bureaus have the ability to sum your entire life up with a number. This number, which is called your credit score, is the result of a statistical analysis of your credit history and represents the likelihood that you will repay a loan within the terms. The higher the score the more likely you are to repay your loan on time. To obtain a conventional loan you must have a credit score above a certain number. Government loans such as FHA, VA and RDA do no require that you have a credit score and, as we have already learned, they allow the use of alternative credit.
The process of calculating your credit score is top secret. Reportedly the three credit bureaus are looking at information such as whether you pay on time, how you use your credit, how much credit you have available, what proportion of your credit accounts are at or near their credit limit, and how often you apply for new credit. Since the process for determining your score is top secret it is very difficult for someone to offer advice on how to improve your score. Even steps that should improve your overall credit may have a negative impact on your score. For instance, you would assume that closing dormant credit accounts, those you haven’t used for some time, would improve your overall credit and hence your credit score. Although you may have improved your overall credit, from the standpoint of eliminating unnecessary accounts, you may also have closed an account that provided strength to your score because of its age and your ability to maintain it for so long.
Without question there are several things that will surely improve your overall credit and credit score. The first is paying your bills on time. The second is to limit the amount of new credit that you apply for. The third is eliminate bad debts from your credit report.
How Can I Improve My Credit Future and Credit History?
Improving you overall credit takes commitment and patience. As you learned above your commitment must be to pay your bills on time and limit the amount of credit that you apply for. This will ensure that moving into the future your credit will reflect timely payment and responsible use. Patience though is required if you trying to resolve negative issues from the past. To resolve the negative accounts on your three credit reports it is important that you have an understanding of some common issues surrounding credit reports and their use.
Credit reports should be accurate, but it is estimated that 4 out of 5 contain mistakes. Today, credit reports are used for much more than determining your eligibility for a loan and the mistakes your credit report contain could be costing you lots of money. For instance, credit reports are used to determine the rates you pay on automobile insurance, renter’s insurance, homeowner’s insurance, and even if you get that new job. There is even a growing trend among couples considering marriage to review their potential spouse’s credit. Less than perfect credit can certainly be a handicap.
With the growing use of credit reports, and the knowledge that the overwhelming majority contain mistakes, it is no wonder why congress enacted the Fair Credit Reporting Act or FCRA. The FCRA is a comprehensive law that governs the credit bureaus and those who purchase a copy of your credit report. It establishes who can legally look at your credit, what can be reported about your credit, the process whereby inaccurate information is removed from your credit, and stiff penalties for anyone who knowingly violates your rights under this law.
The first step in improving your credit is knowing and understanding what is contained in your credit report. The FCRA requires the three credit bureaus to provide you a copy of your credit report upon request. The three credit bureaus are allowed to charge a minimal fee unless you have been denied credit, insurance, rental housing or a job within the past 60-days. There are other situations in which you can obtain a free copy of your report which vary depending upon your home state. It is important that you obtain a copy from each of the three credit bureaus as they each have a separate and distinct credit file. Remember, mortgage lenders will look at the information from all three credit bureaus simultaneously with a merged in-file credit report.
Once you have obtained copies of your report from each of the three credit bureaus it is important that you carefully check them for errors. One common mistake is for the three credit bureaus to confuse you with another consumer who has a similar name, address or other personal identifier. Another common mistake is that past lenders fail to update your record with the credit bureau when you pay the loan off. This is very common when you buy a new car and the dealer pays off your old car, or those student loans that have been transferred from lender to lender. All of these issues make it appear that you have more credit then you really do and give the impression that you are heading for trouble. Another common issue is that participants in group health programs have medical collection accounts resulting from their insurance plan marking down the doctor’s bill, paying less money, and the doctor sticking you for the balance. It is important that you look at your periodic insurance and doctor’s office statements to see if this is happening to you. When it does you should contact your doctor’s office to see if they are willing to write off the balance. Many will as it is assumed your insurance has paid the negotiated rate or fair market value for the procedure or visit. These types of mistakes should be investigated by the three credit bureaus and updated.
It is also a violation of the FCRA for the three credit bureaus to report information which is considered obsolete. Obsolete information is any of the following:
- Bankruptcy filings more than 10-years old
- Civil suits, judgments, or records of arrest more than 7-years old
- Paid tax liens more than 7-years old
- Collections or charge offs more than 7-years old
- Any adverse item not listed above which is more than 7-years old
If you find information on your credit report which is not yours, is not reporting correctly, or is obsolete, then upon your request the three credit bureaus are required to investigate the account within 30-days and remove or update the information if it is found to be reporting incorrectly. The credit bureaus are also required under the FCRA to provide you written results within 15-days of completing their investigation.
When you are satisfied that the information contained in your credit report is correct, the next step is to resolve any open collections, charge offs, judgments, or other derogatory credit items. The credit reports will provide information regarding how to contact the companies who are reporting the information and, as a general rule, it is suggested that you contact the companies with the largest balances first; as it is likely that these debts will have to be set up on a payment plan. Please remember that it is not necessary to have these bad debts completely repaid to purchase a home. It is a requirement however that you demonstrate that you are making an effort to repay them and that you have made 12-months consecutive on time payment. It is important that you obtain the terms of the repayment plan in writing and states that upon completion they will consider the debt paid in full. You should always save copies of your check or money order to document your payments. As you have already learned, the amount of home you can purchase is determined by your debt therefore we suggest that you work out the lowest possible repayment amount to preserve your home purchasing power. During negotiations you may also want to bring up any extenuating circumstances you remember about the account. Since it is likely that you will be contacting these creditors out of the blue it is possible that you may find a sympathetic ear who is willing listen to the details and work out a deal.
Once you have the larger debts established on payment plans you should look at the smaller accounts. Smaller accounts are those that after negotiation you are able to completely pay off with three or fewer payments. Again if you are contacting these creditors instead of the other way around it is possible to get a steep discount. It is not uncommon for a creditor to accept 50% of the stated balance and it is possible to negotiate for less. As outlined above it is very important to get the details of the settlement in writing making sure the creditor considers the debt paid in full upon receipt of your payments.
Once the above steps have been completed you will want to take another look at your credit report to ensure that all issues have been resolved. It is possible that some of the accounts you have recently paid may not be updated. In this event you will want to send the three credit bureaus copies of the written repayment agreements requesting that they investigate and update their file.
Sound like a lot or work? It is! It can also be very frustrating if you do not have the time, temperament, or skills to deal with these past creditors. Every person has a talent. Some people are great at plumbing but not so good at carpentry. You can cut your own hair if you choose to or you can pay $20 and have a professional do it. As with anything, if you need help dealing with your credit issues there are professionals available to help you.