A customer's story
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. Did I do something wrong?"
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.
A seasoned loan means the loan has been paid on time for a sufficient amount of time, giving a lender the reasonable belief that it will continue in a like manner. And the longer you make payments on a loan or save money for a down payment, the better qualified you are as a borrower.
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.
Q&A with mortgage consultant Steve Cartwright
Steve is a Portage, Michigan mortgage consultant, but the advice holds true across state lines. Plus, he's one of many consultants at Amerifirst Home Mortgage. All of our consultants can help you come up with a plan to get your credit in the best shape possible before you apply for a home loan.
Q: 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 it's worse. Why did this happen? Should you avoid paying off collections?
A: Here are a couple reasons why you haven't seen any results:
• Old collections (beyond 12 months) do not report/affect the score
• Paying on an old collection brings it "current" meaning that it basically brings it to the attention of the credit bureaus.
Q: What advice would you give to help someone raise their score, so it's more "mortgage ready?"
A: Here's my advice to help someone raise their credit score:
• Stay below the credit limits
• Don't close any accounts
• Keep paying your bills on time
• Have a credit card or other line of credit for 6 months minimum
Q: So is your advice to "not" pay off collections until you talk to a mortgage consultant?
A: Correct. Paying off current collections will stop your score from falling. Do that. But only after you have talked to a consultant who has reviewed your credit report with you. The key to truly getting your credit in line for getting a mortgage is to talk to a professional, not just look at it and guess on your own.
Q: What are specific things I can do to maintain good credit?
A: Two great things you can do to maintain good credit or improve your credit are to pay your bills on time and reduce the debt you have.
Pay your bills on time
Payment history is the highest-rated factor of your FICO credit score. Even a day late can cause a major hit on your score. That's because prospective lenders view it as a true indicator of how financially responsible you are and is proof - good or bad - on whether you can meet your monthly payment obligations. As you can imagine, lenders are very interested in this number.
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.
If you're working to improve your credit, it's a good idea to check your credit report to monitor your progress and review it for accuracy. You can get a free copy of your credit report from AnnualCreditReport.com.
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.
*Not intended as credit counseling, financial or investment advice. Contact your financial representative for more information.