Charge Offs: All is Not Forgiven

Part of what I do as a mortgage originator is review credit reports. I’m often surprised how many consumers think that a debt that has been charged off means that it has been removed from their credit history or “forgiven”. Basically, a charge off is when the creditor is writing the debt off their books for tax purposes, it is not terminating the debt owed by the borrower. Often times, the charge off may turn into a collection or be sold or assigned to a collection agency and therefore, mortgage lenders will view a charge off on a credit report as a collection.

I while ago, “Betty Bellevue” called me to see if she could help her mom obtain a mortgage. A couple years prior, her mom had a car that she “gave back” to the bank. She thought she would only have a “repo” reflected on her credit report and that enough time had passed to where she might qualify for a mortgage. What she didn’t realize is that even though the bank had the car back, she had a “charge off” for the balance of the car loan on her credit and that for purposes of a mortgage, we would treat it as a collection (it would need to be paid off and removed from the credit report).

Distressed home owners with second mortgages may be surprised to find charge offs on their credit report following a short sale. Borrowers are often caught completely off guard by this remaining damaging debt being reflected on their credit report. Depending on how the lender reports the short sale to the credit bureaus, it may be just as detrimental as a foreclosure. If you are considering a short sale or foreclosure, I strongly recommend you find an attorney who specializes in dealing with this type of situation.  Linda Ferrarri has great information on her credit blog about foreclosures and short sales which I highly recommend if you find yourself facing this situation.

A charge off also dramatically impacts credit scores. Once a charge off, or collection is paid, credit scores will initially drop as the credit scoring modules view it as a “new activity” on the borrowers credit. Eventually scores should recover and improve. If you are considering a mortgage and have charge offs or collections, it’s important to discuss how and when you’re going to pay them off (some can be paid at closing which will prevent your scores from tanking during the mortgage process).  

You can obtain a free copy of your credit report at www.annualcreditreport.com.

Washington State’s DFI (Department of Financial Institutions) guide for home owners who are considering a short sale and Foreclosure Help.

Shallow Credit can leave you in the Deep End when Qualifying for a Mortgage

Shallowcredit 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!

How Returning an Overdue Library Book Declined a Mortgage Loan

Librarian

Okay…it’s not just the overdue library book…we have a few other factors involved with this scenario.   In February I began working with buyer who was contemplating buying his first home, a condo to be exact.   We were able to offer a preapproval based on:

  • mid-credit score of 705
  • 100% LTV Fannie Mae My Community with LPMI (Lender Paid Mortgage Insurance)
  • 5 year fixed 10 year interest only payments (he qualified for fully amortized but opted to have flexibility with his payments)

The buyer, we’ll call him “Joe”, makes an offer on a condo that is in the process of going through a conversion.   The builder also has a “preferred lender” and will only provide a seller credit to the buyer if the buyer uses their lender.   Joe elects to stay with me because the builder’s lender cannot offer the same product and payment options, even though the seller credit was significant. 

Here’s all the scoop:

Joe had an old collection on his credit report from a library book that was overdue.  We had loan approval so I advised Joe to not pay it off until after closing.   Paying off collections lowers your credit score: the credit scoring system recognizes it as new activity on a collection.    Joe finds the book a few months into the transaction and returns it to the public library and paid his overdue collection.   It’s a noble action and would have been perfectly fine…had he done it after closing.

Joe also wanted to make sure he was getting the best deal and decided to continue shopping lenders even though we were locked and approved with his mortgage.  Shop, shop, shop…he did…and the lenders ran his credit report over and over again.   30 inquires over a couple of months HURTS your credit scores.

The condo conversion took months to complete (it was suppose to be done in early May and it won’t be finished until later this month)…so Joe’s credit report expired.   Typically, credit reports are valid for 120 days.   This is when we made the discovery that Joe’s credit score had dropped 40 points.   Forty points may not sound like a lot to you, however…zero down financing is very sensative to credit scores.  There is a tremendous difference between 660 and 700 with regards to your credit score…especially when you’re looking at 100% financing (zero down).   

Joe is a great candidate for FHA financing, however the condo (being a conversion) is not.   Zero down financing with a 660 mid score is not a pretty option.

Lessons (if you’re getting ready to buy or refinance a home…if you’re not, a different strategy may better suit you):

  1. Don’t pay off collections prior to closing UNLESS it is required by the underwriter.   (Pay them off after closing and be sure to get a documentation that they are paid).
  2. To have the best credit score, try to have 3 established accounts that you use at least every 30 days.  This could just be charging a tank of gas and then paying it off every month.   When revolving accounts go “unactive” for a couple months, they are considered “closed” by the scoring system which does not help your score. 
  3. Keep your credit balances below 30% of the available credit line.
  4. If you’re going to shop your Mortgage Professional, don’t let other LOs pull your credit.   You all ready have your scores and that is all the information a LO needs for a rate quote.
  5. Your documentation (such as credit reports, paystubs, etc.) are only valid for a certain time period.   With longer transactions,  be aware that your credit report may be re-pulled and/or employment may be re-verified.
  6. Return your library books before they become overdue.