Give Your Credit Score a Not-So-Extreme Makeover
The goal of your mini-makeover is just to spend a month or so making sure that your personal stats paint as pretty a picture of your financial resources -- FICO scores, debt-to-income (DTI) ratios, reserves, and down payment money -- as they can, not to do a Dr. 90210-style surgical reconstruction of your entire financial life.
Make Sure Your Stats are Accurate
Credit reports are notorious for containing erroneous information, due to incorrect reporting by creditors or fraud. I once had a client come in who should have had good credit, based on her history of paying her bills. When we pulled her credit report, though, many delinquent credit accounts that she had never even heard of were listed in her name and under her social security number. Her investigation revealed that her own brother had been committing identity fraud against her for years! She never would have known if she hadn't pulled her own reports in the process of preparing to buy a home. By filing a police report and aggressively disputing the fraudulent entries with the creditors and the credit bureaus, she was able to dramatically improve her FICO score. The upshot? As soon as you get your credit reports from annualcreditreport.com, read them! Print them out or ask them to mail you a hard copy, and go through each report with a fine-toothed comb, marking it up when you see:
- Late payments that weren't actually late;
- Account balances listed that are higher than your actual balance;
- Credit limits that are lower than they actually are;
- Accounts that do not belong to you;
- Accounts you thought were open that are listed as closed;
- ANY other incorrect information.
Do the Quick Work
- If you have any credit lines that are over the credit limit, pay them down below the limit -- immediately.
- If you have a surplus of cash in the bank available for discretionary use (e.g., more than five percent of the purchase price of the homes you're looking at) or your credit limits are fairly low, consider paying as many bills as possible down to 30 percent or less of their limits. For example, if you have a credit card with a $600 limit, pay it down to $180 or less.
Here's how to do this: rank all of your credit accounts from lowest to highest limit. Start at the top and work your way down the list, multiplying each credit limit (not the balance) by .3 to figure out what 30 percent of each credit account's limit is. Then go back up top, and list the current balances all the way down the list. Go through the list one last time, subtracting the 30 percent amount from each balance, to see how much cash it would take to bring each balance down to the 30 percent target. If there are any accounts you can afford to pay down to 30 percent without depleting your reserves, do it today! Don't pay them all the way off -- the 30 percent target is what FICO looks for to show that (a) you are not financially dependent on your credit cards, but (b) you are responsible enough to use credit and pay your bills as agreed. And don't worry about the really big bills. If you owe $19,000 on a student loan with a $20,000 limit, it would take you $13,000 to pay that loan down to 30 percent of the credit limit. If you have that much cash, paying that loan down is probably not the best use of it when you're considering buying a home. Plus, in the time it takes to save up to pay a really big bill off, the home of your dreams might be a whole lot more expensive than if you had bought it before you paid the large debt off. Pay down the smaller ones and keep the rest in the bank for your down payment, closing costs, reserves, or your bill at Home Depot or Lowe's once you move in!
- If you happen to be one of those uber-responsible folks who uses credit cards for everything, then pays them off every month -- STOP that practice until you are warmly ensconced in your new place. Credit scores are a snapshot -- the creditors only report your account balances once a month. If your account picture is reported on the day of the month you have huge balances, rather than the day when you've paid them off, your report will look like you are living on your credit cards! The 30 percent of credit limit benchmark is an ideal account balance to maintain for purposes of maximizing your FICO score -- not more and, surprisingly, not less. So, until you have actually secured your mortgage, stop running your cards up beyond that 30 percent, even if you plan to pay it off every month.
- If you have cards that have been unused at all for awhile, or lots of cards with no balances, go use a few of them, but refrain from going over that 30 percent of credit limit target. You want to show that you have the financial ability and the ethics to responsibly use credit.
Do the Easy Work
Reserves. If you don't have at least three months' worth of mortgage payments in liquid assets, your credit score is less than 700 and you have a relative or VERY close friend who has enough money in the bank to suffice for your reserves, consider asking her to add your name to her accounts. It takes a single trip to the bank, her willingness to sign a document attesting to the fact that she is giving you access to all the funds in their account, and a TON of trust (on her part) and responsibility (on yours). Most people can qualify with or without reserves, but many times the rate-reducing effect of having reserves can expand your purchase price limit. It is definitely worth doing if someone in your life can make her funds available to you. This is the new age alternative to getting a co-signer, allowing you to get some help without putting the co-signer's credit on the line or making her responsible for making your payment if you can't.
Gift money. If you have "wealthy relations" or really nice parents who have indicated that they plan to give you money to help pay for your down payment or closing costs, get this money in the bank sooner rather than later. Unless your benefactors give you a full 20 percent down payment, most lenders are going to require the gift money to be seasoned (i.e., in your bank accounts) for at least two months prior to the time your mortgage professional submits your loan application to the lender (just to be sure this isn't a super short-term loan). So collect any promised gifts, put them in your bank accounts, and spend your waiting time writing really nice thank you notes.
Student loans. Student loans seem like the warmest-and-fuzziest of all the sorts of debt you can occur. You only incur them if you've been proactive in improving your life, the interest is low and tax deductible, and they'll let you postpone paying them ad infinitum if you just call them up and whisper the magic word "forbearance." With a student loan, your "limit" is simply the loan amount you had when you graduated. During forbearance periods, the interest is tacked onto your account and your balance could grow beyond your "limit." If you've taken advantage of the forbearance process for any significant period of time, and you are less than 10 years out of college or graduate school, your student loan might very well show up on your credit report as being over the limit.
If you see on your credit reports that your student loans are designated both "Pays as Agreed" and the balance is reported as a greater amount than the credit limit, there are three ways you can fix this. All are worth considering because of the sheer size of most student loans, which have a proportionally large impact on your FICO scores:
- Pay your student loan down below the "limit" -- this is only feasible if the amount over the limit is within reason;
- Call up your student loan company and ask them if they will adjust what they are reporting as your loan "limit" to match what your loan amount currently shows (if they agree, ask for a hard copy letter that documents the "new" loan limit in writing -- you may need it to get your credit reports changed); or
- "Consolidate" your old student loan into a new one at the same interest rate or lower, which will reset the loan limit at whatever the loan amount is at the time.
As soon as you have finished doing all the paying down and student loan-type work that you are going to do from the list above, go through your credit report one last time and check off all the items that should be different now than they were when you originally pulled them. Now, you need to initiate the dispute process with each of the three credit bureaus for (a) all of the erroneous or fraudulent items, and (b) all of the items that you have caused to change while you were doing the quick work and the easy work, above. Once you dispute an item on your credit report, the credit bureaus immediately make a put up or shut up proposition to the creditor who was reporting the disputed item. If the creditor does not validate the disputed item within 30 days, the credit bureau erases it from your report.
It may take two or three rounds of disputes to get your report clear of all the incorrect items. I cannot impress enough the importance of moving forward with your homebuying process after the first round (while continuing to dispute errors until they are gone). As you improve your credit score through further rounds and through responsible use of your credit, your FICO scores will move up and your risk ratings will decrease, and you can refinance into progressively higher grade (i.e., lower interest & better terms) mortgages.
Do not wait for further rounds of credit report disputing to be complete unless:
- Your credit score is still under 580 -- FICO scores below this point qualify only for severely subprime loans. If errors or accurate delinquencies on your credit reports are placing you below this point, it may very well be worth waiting until they are gone or less recent.
- Your mortgage professional tells you to wait -- Every once in awhile, a client will have a credit score of 698 and the ideal loan program for them will require a mid-FICO of 700. There's no hard and fast rule for knowing when it's advisable to wait because your score is on the cusp of a hundred-point mark, except that once your score is over about 740, there's really no advantage to waiting (the best loans are offered to people with scores over 740 -- it makes no difference whether the score is 750 or 800). It totally depends on whether an increased score would make an improvement in the rate or terms for which you qualify -- and that's a question for your mortgage professional.
When you've received your revised credit reports, recalculate your personal statistics, including your new FICO scores. Other than the numbers, there is a short list of qualitative questions to ask yourself to round out your personal profile before you start looking for a compatible mortgage:
- Fluctuations in Income -- Is your income steady, or does it fluctuate monthly or seasonally?
- Priorities -- What are your priorities for the financial side of this purchase? Are you trying to get maximum appreciation, get as low a payment as possible, or fit your five kids in as big a house as possible?
- Your Tax Situation -- Do you usually have to write a big check at tax time?
- Your Exit Strategy -- Why will you relocate when you move from this home? (Answers I've gotten to this question range from getting into a better school district to "they'll carry me out in a pine box.")
With this list in hand, you know enough about yourself to start weeding through the mortgage program types and start figuring out which of them might be compatible with your life!