Here's a story relayed to us by one of our mortgage consultants. A hopeful home buyer calls him up and says, "I want to buy a house so I need a mortgage. My bank told me I need to improve my credit score, and I should pay off my collections on my credit report. I did, but my score didn't go up and they can't help me. What can you do for me?"
Sound familiar? Maybe you have a collection on your credit report and you're thinking that if you just pay it off, your score will go up and you'll be able to buy that dream home you found last month.
Not so fast. Before you go making any changes to your credit history - like paying off collections, closing credit lines or refinancing a car loan to get a lower payment - you should talk to a mortgage professional about how these actions might affect your credit and your chances of getting a mortgage.
Did you know that lowering your 2-year old car payment by refinancing actually gives you a new line of credit? New lines of credit aren't considered "seasoned," which is bad news for someone looking for a mortgage. The older your credit lines are, the better. A new car loan is bad, but a 3-year old car loan shows you make regular, on-time payments. That's a good thing.
When it comes to paying off collections, it's certainly good to clear your credit report in the long run. However, paying off a collection also brings the report "current," which can actually drop your credit score in the immediate time period. Also, paying off collections typically stops your score from dropping long-term, but doesn't usually raise your score. Instead, keeping balances below 30% of their maximum will help raise your credit score. For example, a $10,000 limit on a credit card shouldn't go above $3,000.
Watch the short interview with mortgage consultant Steve Cartwright. Steve is a Portage, Michigan consultant, but the advice holds true across state lines. Plus, he's one of many consultants at AmeriFirst Home Mortgage. All of our consultants act as advisers when it comes to getting your credit mortgage-ready.
See the embedded video here - Why Paying Off a Collection May Hurt Your Credit Score
So your bank's mortgage person has told you to pay off all your collections to help get your FICO score ready to buy a home. Then you go in to officially apply, and your score is the same... or maybe even it's actually worse. Why did this happen? Should you avoid paying off collections? We have some great information and tips from a mortgage expert coming up right now on "Mortgage Minute TV."
Thank you for joining us today on Mortgage Minute TV. My name is Dan Moyle. We're talking credit scores, collections and home loans with Portage, Michigan mortgage consultant Steve Cartwright. Thanks for joining us Steve.
So Steve... let's dive into the world of credit and home loans. In the story about the home buyer who pays off a collection, then sees their score stay the same or get worse, why does that happen?
• Old collections (beyond 12 months?) do not report/affect the score
• Paying on an old collection brings it "current" (what does that mean?)
So paying an old collection basically brings it to the attention of the credit bureaus?
Okay, so if you're looking at a home buyer's credit report, what advice would you give to help raise that score, so it's more "mortgage ready?"
• Stay below the credit limits
• Don't close accounts
• Keep paying the bills on time
• Have a credit card or other line of credit for 6 months minimum
So is your advice to "not" payoff collections until you talk to a mortgage consultant? Maybe it's something where you can pay them off once your loan is closed?
• Correct. Paying off current collections will stop your score from falling. Do that. But only after talking to a consultant and looking over your credit report with them.
So the key to truly getting your credit in line for getting a mortgage, you really need to talk to a professional, not just look at it and guess on your own.
Thanks for watching. You can find resources for credit and mortgages in the YouTube description below. For Mortgage Minute TV, I'm Dan Moyle. We'll see you next time.
Two major pieces of advice for maintaining good credit or improving credit are: Pay your bills on time and reduce the debt you have.
Pay Your Bills On Time
Even a day late can cause a major hit on your credit card score. Paying on time accounts for 35% of your FICO score. It’s the highest-rated factor.
Reduce the Debt You Have
While it’s easier said than done, bringing down the amounts you owe on credit cards and other accounts will have an impact. Take a look at your accounts, figure out how much you owe, and begin paying them down. Also, put the credit cards away and tighten the budget. Pay off the what you can, while paying at least the minimum payments on the rest of your accounts.
Still have credit questions? Check out more helpful articles on our blog.
If you're looking for more information on how to get your credit mortgage-ready, or you just have more mortgage questions in general, download our free guide at the button below. The eBook is a quick read with tips, information and more to help you get on the road to buying a home.