Take a look at John's excellent post about reestablishing credit. Well worth your time.
REESTABLISHING YOUR CREDIT TO GET A MORTGAGE LOAN - DALLAS, TEXAS HOMES AND REAL ESTATE
Despite the various reasons why people may find themselves in a financial bind that damages their credit rating, the major obstacle that stops most from rebuilding their credit is lack of knowledge regarding how credit scoring works and what specific steps should be taken to ensure a quicker recovery.
The popular myth is that once a person's credit score is damaged from late payments, collections, a bankruptcy or even a foreclosure, those issues must be resolved or removed from their credit report or they face a seven year curse of bad credit.
It's almost like the old tale about breaking a mirror - once the damage is done, the only thing that can remove the curse is to wait around for the seven years of bad luck to pass.
This myth ends up becoming a self-fufilling prophecy because doing nothing instead of taking proactive steps to rebuild credit will often guarantee a prolonged period of bad credit. And when it comes to qualifying for a mortgage loan, lenders are usually forgiving of past mistakes if a new track record of responsible credit history can be established after the fact. And that is true even in today's new reality of tighter mortgage qualification guidelines.
In many cases, a person who encounters a major setback such as a repossession or bankruptcy may be able to qualify for a mortgage in as little as two years. In other cases of minor credit issues, such as sporatic late payments and/or collections, the wait time to qualify for a mortgage might even be less than a year, depending on the overall situation.
In cases where a home loan applicant has experienced past credit issues, a mortgage lender will typically want to see THREE things before they will consider approving them for a loan:
- An explanation and sometimes documentation of the reason for the bad credit and some type of assurance that this resulted from circumstances that are not likely to recur. Some oversimplified examples of this would include a job loss, a divorce or ending of a relationship, an illness or injury, a death in the immediate family or some other type of event that most everyone experiences at some point in life that results in a financial hardship. Even an admission of irresponsibility with regards to past finances may be acceptable, provided the applicant has since demonstrated the ability to manage their finances properly.
- A twelve month history of on-time payments on at least three accounts, preferrably accounts that report the payment history to the credit bureaus. This usually also includes a satisfactory rental or mortgage payment history for the last 12 months. This is a MANDITORY MINIMUM REQUIREMENT to obtain most types of mortgages. It is also the one thing that most consumers aren't aware of that keeps them from qualifying for a home loan for a much longer period of time after experiencing a financial setback that adversely affects their credit rating. Many assume that since bad credit lingers on their report for seven years, it may take that long before they can qualify for a mortgage. The secret is knowing how to obtain credit with a bad credit rating.
- Proof that the applicant has sufficient resources to afford the monthly mortgage payment and that they will likely be able to pay on time each month. Of course, this is something required of all home loan applicants regardless of past credit history. This boils down to character, capacity and capital, known as the "three C's of underwriting". Character can be summed up to a person's overall credit and payment history, capacity is their ability to repay (income and stability of employment) and capital is both the down payment (equity) and the amount of money they will have left over after closing. Every loan has specific requirements for each of these, and a strength in one area may help to overcome a weakness in another, depending on the overall picture.
So the real question is "How does a person with bad credit go about obtaining credit in the first place?" Well that's actually easier than most people think. Secured loans and secured credit cards are a form of credit that can be obtained by virtually anyone, regardless of past credit history.
What is secured credit? It's basically any type of credit that is secured with collateral (in this case, CASH). Most banks and nearly every credit union offers secured credit cards, but very few actually promote this service.
A secured credit card usually requires a minimum security deposit of $300-$500 dollars, which is held as collateral for repayment of any balance incurred on the card. The credit limit is usually equal to the amount of the deposit. In other words, a fully functional, major credit card that reports to all three credit bureaus can be obtained by nearly anyone by simply putting up a cash deposit in a savings account with a bank or credit union that offers this service.
And in addition to secured credit cards, many of these institutions offer secured installment loans as well.
But why on earth would someone put up a $300 deposit to obtain a credit card with a limit of $300? Doesn't it make more sense to just spend the cash and avoid credit entirely? Well, normally it would. But the purpose of obtaining a secured credit card isn't to actually borrow money, it's to reestablish a solid credit history.
Unfortunately the credit bureaus can only generate a credit score based on data that's reported to them by creditors, not on other factors such as income, employment or a person's ability to save money. And paying bills such as insurance, utilities and rent do not usually help one's credit score since these companies rarely report the payment history to the credit bureaus.
So unless there's something to report, the bad credit from the past is the only thing the credit bureaus have to consider. And that's where people get into a pickle with credit once they've had a setback and have closed all of their past accounts. The secured credit card is the catalyst that helps to actually rebuild the credit score.
Having said all of this about credit repair and restoration, I would not recommend someone buy a home that isn't financially ready for the challenge. Owning a home isn't like renting, it requires a steady supply of time and money to own and maintain a home. There is no maintenance man to call when the toilet overflows at 4AM or the air conditioner stops working in August.
Rebuilding credit is very important, but rebuilding and reestablishing overall financial health, including building up a six to twelve month reserve of cash, should be top priority for anyone who has experienced a financial setback.
IF YOU HAVE HAD A PERSONAL FINANCIAL AND/OR CREDIT SETBACK AND WOULD LIKE MORE INFORMATION ON THE RIGHT STEPS TO TAKE TO REBUILD YOUR CREDIT, PLEASE CALL OR EMAIL ME TO SET UP A CONSULTATION. I WORK WITH A NETWORK OF LENDERS THAT SPECIALIZE IN CONSULTING WITH CREDIT-CHALLENGED CLIENTS THAT NEED SOME FREE GUIDANCE ON WHAT STEPS TO TAKE TO QUALIFY FOR A HOME LOAN AS QUICKLY AS POSSIBLE.