I find that most consumers who are concerned with their credit feel that a credit blemish from years ago will keep them from homeownership forever. That couldn’t be farther from the truth. Loan guidelines for a federally backed FHA mortgage only requires 3 years from a foreclosure, 2 years from a chapter 7 bankruptcy and 1 day on a chapter 13 bankruptcy discharge! What does that mean? It means that regardless of your credit past, you can probably qualify for a home loan in just a few years. Often consumers will qualify and not even know it.
The key to building your credit after a financial catastrophe is creating credit activity immediately. The most common mistake I see people make is they never re-establish credit following their financial fallout. If your credit was horrible after a bankruptcy and you never opened a new credit account, it will remain horrible. Most consumers think that there is no way to build credit because they will not qualify for a loan, which makes sense. However, there is a way.
Here are some basic ways to build credit when your credit score is low:
Open a Secured Credit Card-
- You can open a $100 credit limit card if you deposit $100 to the lender. You can often get these from any bank or credit union. The lender is willing to issue the card regardless of your credit because it’s secured by your cash deposit.
- Open an Unsecured Credit Card or Installment loan
- After you’ve had a secured credit card for 6-12 months, you should establish enough credit to open an unsecured card. The rates you’ll be offered will be fairly high, so try to pay the balances off during the grace period. Avoid cards with annual fees if possible. You can also then apply for an auto loan if you need one.
- Keep Your Credit Cards in Good Standing and Avoid Paying Unnecessary Finance Charges
- Keeping your credit card in good standing includes paying your bills on time. It also requires you to keep your balances low. Never let your balances exceed 25% of your limit. That may seem low, but keep it there and your score will remain high. As your score builds, you can request higher limits. You can then lend up to 25% of your new balance. Also try to pay the balances off during the grace period to avoid interest charges. I often tell clients to treat the new card like a debit card. When you make a purchase, use your receipt and transfer that much money from your checking account immediately.
- Monitor Your Credit and Dispute Incorrect Items
- Most credit reports are inaccurate. The last thing you need pulling down your credit is an account that doesn’t even belong to you. Check your credit regularly with a monitoring system and dispute items that are incorrect. You can also pull a free credit report on www.annualcreditreport.com. This is very important for people who have gone through a bankruptcy because creditors often do not update account information following a bankruptcy.
- Pay Your Collections Early
- When a collection has been on your credit for too long, it sometimes temporarily LOWERS your score when you pay a collection off. Eventually, it will benefit your credit to have it paid, so pay the collection as soon as possible. If you’re thinking of paying off a collection and are near qualifying, look to see when the last time that collection agency reported the debt. If they haven’t reported any updates for a year or longer, you will likely want to hold off on paying that account in case. It’s best to pay the collections before they report on credit. If you’re score is far too low to qualify, pay them all. Letting the collection balance linger can be bad juju. The collection agency can sell the debt to another. You can end up having multiple collections on your report for the same debt. Not good.
Not all mortgage lenders are the same, but most follow the same minimum credit guidelines. If you want to buy a home, shoot to achieve these goals on your credit:
- Try to achieve a minimum 620 credit score or 640 credit score for two of your three credit scores. These are the industry standards for obtaining a FHA loan, which only requires 3.5% down.
- Pay off all liens and judgments immediately. You will not be able to buy a house if you have outstanding judgments or liens.
- Keep at least 3 credit accounts open at all times. If a credit card company ever makes you mad, DO NOT CLOSE IT! Just cut up the card and pretend it doesn’t exist. Closing accounts is bad for your credit. Mortgage lenders may also require at least 3 open credit accounts to qualify for a home loan.
- If you’re had a bankruptcy or foreclosure, it’s very important that you show you can pay your bills on time following the event. Many lenders will turn you down for a home loan if you’ve had late payments following a bankruptcy or foreclosure.
If it’s possible, look for a loan officer who’s goal is to help you obtain homeownership regardless of where you stand now. I tell all my clients that if they’re serious about buying a home, they will eventually get there if they follow the right advice. Find someone who’s educated enough to give you the advice needed and is willing to work with you along the way.
Here are the required waiting periods to qualify for a home loan following a hardship:
FHA- 3 years. Circumstances allow less than 3 years if the homeowner wasn’t late during the shortsale or circumstances were outside the homeowners control.
Conventional- 2 years with 20% down, 4 years with 10% down or 7 years with no restrictions
VA- 2 years
USDA- 3 years unless USDA’s underwriting engine (GUS) approves you sooner. Typically 2-years with re-established credit.
FHA- 2 years for Chapter 7. None for Chapter 13.
Conventional- 4 years for chapter 7. 2 years from discharge or 4 years from dismassal for Chapter 13.
VA- 2 years
USDA- 2 years
FHA- 3 years
Conventional- 7 years
VA- 2 years
USDA- 3 years
Fannie Mae Seller Guide
Mortgagee Letter 09-52
VA Lender Handbook