Heather and her husband got caught up in the neverending downward spiral of taking payday loans to pay off payday loans. Each time they got a paycheck they had to use the check to pay off the interest on those loans and then didn't have enough to pay their utility and other bills. Finally, they realized they were in over their heads and filed for Chapter 13 bankruptcy in 2008.
They're nearing the end of the bankruptcy, which will be completed by December, and wanted to buy a house. "We wanted to do what we needed to do to improve our credit score so we could buy a house," Heather said. They worked with specialists at Flagship Financial
to improve their credit history and boost their score, so they could buy that house.
When they started working on their credit score in June 2010, Heather's was 575 and her husband's was 590. They were advised to take several steps to improve that score which needed to be at least 640 before they could get an FHA loan. The most important thing was to develop a budget. "If you don't have a budget then you're going to fail," Heather said.
They were also told they needed to get a secured credit card so they could show a credit history of paying their bills on time. At first they made the mistake of paying the bill even before the credit card statement was out. But, Heather explained that didn't help because a zero balance was reported to the credit reporting agency. So they changed tactics and now keep about a 30 percent balance on that card each month and pay if off when they get bill. They don't allow the final bill to be reported to the credit agency to be more than 30 percent of their available credit, so they will make a payment before the statement closes if the bill will show a higher balance.
They also made sure to pay bills on time, such as the electric bill, phone bill and cable bill, so they have a long history of on-time payments. In January 2011, Heather's credit score jumped to 660 and her husband's to 700. They now have the credit scores they need and will be closing on a house by the end of January.
Heather and her husband made some very common credit mistakes. Getting caught up in pay day loans was the biggest, but that led to not having the money to pay other bills on time. You must be able to show that you pay your bills on-time for at least 12 months without any late payments to get a mortgage today, Eric Kandell of Flagship Financial explained. That includes something as low as a $15 AT&T bill. One missed payment in the past 12 months will kill your application for a mortgage.
Here are some other credit mistakes you must avoid to maintain a good credit score and get a mortgage:
•Don't apply for any new credit cards in the six months before applying for a mortgage. Each time you apply for a credit card it reduces your credit score by 10 to 20 points and it can take six months to get those points back.
•Don't co-sign on a loan for anyone, even a child, in the six months before applying for a mortgage. If you do co-sign and that person misses a payment, the missed payment will show up on your credit report. So if you have co-signed for a loan in the past be sure the payments are being made on time.
•Don't close any credit cards. Closing a credit card will reduce the amount of credit you have available and increase your credit utilization ratio. To get the best credit scores your credit utilization ratio should be between 10 percent and 20 percent. So if you have $10,000 worth of credit, $2,000 would be a 20 percent utilization ratio (2000/10,000). If you have two credit cards, each with a $5,000 line to get that $10,000 worth of credit and you cancel one card, you'll have only $5,000 available credit and your credit utilization ratio would jump up to 40 percent. Your credit score would drop dramatically and you probably would not be able to get a mortgage.
•Debt settlement can kill your chance of getting a mortgage for years. Don't believe anyone who tells you debt settlement will help improve your financial situation so you can get a mortgage.
•Don't buy a new car before buying a house. If you're planning to buy a house, do that purchase first. Many people can't qualify for a mortgage with a new car payment. Their debt levels are too high, so get the house first.
•Don't shop for credit just before applying for a loan. Yes you want to find the best interest rate, but each time you shop for credit the creditor checks your credit score. Do your research but avoid having your credit score pulled until you're ready to apply.
•Don't sign up for a 10 percent discount that requires you to open a new store credit card. The store will check your credit and that inquiry will lower your credit score.
•Don't buy everything with cash. You need to show to lenders that you can pay your bills on time. People who buy everything with cash don't have a credit history that can be used to build a good credit score.One of the biggest mistakes people made during the recent downturn was to work with someone to try to get a home loan modification. To get help they had to stop paying the mortgage and now their credit is ruined. Unfortunately if you're in that boat there isn't much help for you out there. You will need to wait several years to rebuild your credit score, but it can be done by paying your bills on time and reducing your debt.
Lita Epstein has written more than 25 books including The Complete Idiot's Guide to Personal Bankruptcy and The Complete Idiot's Guide to Improving Your Credit Score.