When in comes to qualifying for a mortgage, lenders are generally looking for borrowers who have established a history of paying their obligations on time. Ideally this would consist of four accounts that have been open and used for the last one to two years. When someone does not have active accounts, or when their accounts are all new, their credit history appears “shallow” to some lenders.
You don’t have to be a first time home buyer to have “shallow credit”.
Recently I helped a couple in Bellevue who were buying a “move-up” home using a jumbo loan for financing. They had excellent credit, plenty of savings and liked to pay cash instead using credit. When they did use credit, they would payoff and close the account immediately. You could see they had a credit history, they even had stellar credit scores, but they lacked having active trade-lines. One lender that we worked with actually declined the loan. Luckily we have several resources for non-conforming mortgages and we closed on the transaction after we switched to a different lender with less rigid guidelines.
Credit scores are impacted more dramatically for borrowers with “shallow credit” over those with established credit.
Because the borrower has less of a credit history to illustrate their borrowing and repayment patterns, their credit scores tend to be more sensitive to situations than a person with a long established good credit history. Don’t get me wrong, an established credit user with great scores will suffer a ding if they make a late payment or open a new debt, however it tends not to be as damaging as it is for someone with a lighter history.
What can you do to improve your credit history? Here are some tips for if you are considering getting a mortgage:
- Pay your debts on time. NOTE: paying off and closing an account where you have made a late payment will not erase the damage from the late payment…in fact, it might hurt your score more if that account was established…
- Do not close established credit accounts. Credit bureaus LOVE established credit history. If you have an older account, you may want to consider using it to buy a tank of gas or groceries and pay it off each month. If the account is not kept active, it will eventually be treated as a closed account and you will no longer receive points for that positive history.
- Do not obtain new debt. New cars and credit cards will drop your score. Not only is it a new debt “ding”, you’re also getting dinged for having a debt at 100% of it’s credit line.
- Keep your debts below 50% of the credit limit (30% is even better). For example, if you have a credit card that has a credit line of $1,000; try to keep your balance below $500 or 50% of that credit line.
- WAIT to pay off collections. Sadly the scoring system factors this as new activity (kind of like getting a new collection) against your score. Often times it may be best to pay off the collection at closing if needed. Your Licensed Mortgage Professional can help you determine this.
Other tidbits about credit scoring…
- Size doesn’t matter with credit scoring. Paying down a smaller credit card has the same impact as paying down a larger one. (I recommend starting with the accounts that will take the least amount of funds to pay down). And a $70 collection hurts your score just as much as a $700 or $7000 collection.
- Charge-offs hurt. Many borrowers believe that because the creditor has written off a debt, they’re in the clear when they actually still owe on the debt. When a charge-off is reported to the credit bureau, they are viewed (and scored) as a collection.
If you are planning on buying a home in the next year or refinancing, it doesn’t hurt to start very early with a mortgage professional who can help you review your credit and provide advice to help you be in the best position possible. It’s more important than ever with tighter underwriting guidelines and mortgage rates that are based on credit scores. I often meet people who have tried to fix their own credit, believing they’re doing what any normal person would believe are the right things (like paying off debt and closing accounts) only to discover they’re scores have tanked. It takes time to repair or establish good credit.
If you, or someone you know, is considering buying or refinancing a home anywhere in Washington, I’m happy to help!