Dealing with a Poor Credit History
Maybe you already know that your credit report is a little messy. Delinquencies, for example, have been recorded, and as much as you hate to admit it, they are correct. Now what do you do?
Be prepared. Were you delinquent in paying bills for four months last year because you were laid off? Because you had serious surgery? Was there a death in the family? A divorce? Send a letter of explanation to the credit bureau and ask them to affix it to your report to serve as an explanation for anyone requesting your file. Be ready to explain your reasons to the mortgage loan officer as well. Copies of doctors' bills can help document long illnesses. If you had a dispute with a credit card company over a payment that is still being worked out in correspondence, bring copies of those letters with you to the lender.
A copy of your credit report is free in some cases, including the following: if you have been denied credit, employment, or insurance within the past sixty days; are unemployed or on welfare; or if you suspect credit fraud.
If you have no good explanation for the six months or even two years of late payments, you will just have to work around that black mark. Explain to the mortgage loan officer that you are more responsible now about your debts. Be willing, if possible, to make a larger down payment than would normally be required. A lender will be more willing to take a risk loaning you money if you can demonstrate that you have changed your ways.
Another way around a poor credit history is to use a pledged account.
This means the lending institution keeps extra collateral available in a third-party escrow account in case of your nonpayment. You supply funds equal to three or four months of your mortgage payment in an account managed by some third party. This could be the seller, a title company, or even your employer. You can use cash or another type of collateral, such as stocks, bonds, or certificates of deposit, for this fund.
The escrow instructions will state that this money is to be used only for any delinquent loan payments and late fees for the first three years of the loan. If the loan is in good standing at the end of that time, the funds, plus any interest accrued, are returned to you.
Bankruptcy is more serious than late payments. If you can afford to buy a home now, however, do not let that blot on your credit keep you from approaching mortgage loan officers. There are, legally, no time limits on how soon you can secure a conventional mortgage after a bankruptcy is discharged, although some lenders will turn you down no matter how long ago it occurred. With FHA-insured loans, a bankruptcy must be discharged for at least one year; the Department of Veterans' Affairs insists on a two-year wait. When applying for a home loan in this instance, you must anticipate the following:
A good deal of shopping around among lenders
Telling the truth about your situation and appearing remorseful and apologetic, not cavalier or casual
Giving an explanation of what caused the bankruptcy
The need for a scrupulously clean credit report since the bankruptcy
Paying a sizable down payment, perhaps 20 percent or more
Utilizing some less conventional sources for funding
In dealing with lenders after you have had credit problems, keep in mind the words of one mortgage loan officer: “The important thing is to be honest and open with us and to have a good explanation for what happened. We don't like surprises.” Focus on the last four words. Banks and other lenders are ultraconservative institutions; the unexpected makes them very nervous.
Keep in mind that if you have not used credit since a bankruptcy, you will need to build up a credit record by charging inexpensive items or taking out small loans and then repaying them promptly. If there is no repayment record since the bankruptcy, the lender will not know if you can now handle debt.
You are striving to show as much in savings as you can muster and as few debts as possible. Pay off as many bills as you can before applying for a loan, and, as mentioned earlier, convert as many assets to cash as you can to build up a sizeable savings account. Put off major purchases until you have that mortgage nailed down.
Have answers ready for any point that does not look good on your application. If you have changed jobs frequently, for instance, prepare to explain to the lender that each was a move up — in terms of higher salary or expanded experience. If there are snags in your credit history, be prepared to explain them.
If you have trouble finding a lender because of your credit history, you may need to consider some less conventional methods of securing mortgages. They may not be as common as a standard loan from a bank, but these resources may be less stringent about qualifications. You have several options:
Mortgage brokers. A mortgage broker will know a variety of lending institutions across the country and will be able to find a lender willing to work with buyers with less-than-perfect credit histories.
Seller's mortgage. This is offered by the seller of the home for a term of three years or so, after which you secure a mortgage.
Assumable loans. You can take over someone else's mortgage, such as one offered by the FHA or VA, often with no need to qualify on your own. Adjustable-rate loans can be assumed; in general, fixed-rate loans cannot be assumed.
Lease/purchase. Renting with the option to buy at the end of a specified period is discussed in Chapter 2.
Cosigner. Parents or another family member might cosign your mortgage, thereby increasing the likelihood your application will be approved (but also making them responsible for the mortgage if you cannot make the payments).
