Friday, June 27, 2008

Fixing Credit for Home Purchase

I still answer phone calls almost daily from people wanting to get pre-approved for a home loan who have no down payment and a credit profile with more problems than the agent responsible for resurrecting Brittany Spears acting career. These are well meaning people who could buy a home for what they are paying in rent, if only their credit allowed them to do so.

A well dressed couple sitting across from the desk from me tells me they want to purchase a $175,000 home in a nice subdivision here in Edmond. “My credit isn’t so good. My score is about a 560. I’ve been working on improving my scores, but I don’t know how to speed up the process.”

Genuine empathy is the best way I can describe my feelings for this couple. He continues. “We pay our mortgage and credit card payments on time but the three credit cards we have are maxed out at the $500 limit. The limits are so low because when we got them our credit was really bad. We’re not sure if we should pay these balances off. And we don’t know how to get the recorded slow pays and collections off our credit report.”

This is just one example of the many that regularly come my way. Make no mistake, their credit score of 560 is much worse than “not so good”, it’s awful. Consider that credit scores range between 300 and 850 and that half the adults in America have at least a 700 credit score. Anything below 620 is considered sub-prime. Even FHA cuts off loan approval for scores below 580.

According to credit score creator Fair Isaac, people with credit scores between 550 and 599 have a 51% chance of defaulting on a home loan or any credit account. Contrast this figure with the 2% likelihood of default from people with scores over 750 and it becomes obvious why lending guidelines have tightened significantly for lower scored borrowers.

There is no “quick fix” for credit scores. Think about it; you probably didn’t get into your situation over night and you’re not going to get out of it in a week or two. Most likely it will take several months or even years to correct negative credit reporting.

Still you can speed up the credit repair process by paying all credit card balances in full and never use more than 10% to 20% of the available funds on any one card and pay those balances in full each month. This is the fastest way to improve credit scores.

If you find yourself using 30% or more of the available balance each month, you should consider asking the card carrier for an increased limit. By keeping the amount of utilized credit at or below 20% your scores should realize the maximum benefit.

While rebuilding credit scores it would also be a good idea to be saving up money for a down payment and closing costs. Unless you are a veteran with V.A. benefits, the smallest down payment any lender allows is 3% of the purchase price. Both Fannie Mae and FHA have these programs. V.A. home loans still allow qualifying veterans to finance up to 100% of the purchase price.

In addition to the down payment you should plan on saving enough to cover your share of the closing costs. For a $200,000 home you should expect between 2% and 3% in closing costs. For a $100,000 home the percentages are higher. Check with your preferred lender to get an accurate cost estimate. This way you’ll be able to set an accurate savings plan.

There are professionals who specialize in credit repair and enhancement. Should you decide to use these services, carefully check out their track record by asking for and calling several of their previous clients. The guidelines for home purchases have tightened and will probably tighten again before they relax. If your credit is challenged, let me assure you that it is worth the time and effort to repair it.