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Managing Your Credit Wisely

Whether you're a first-time buyer or a seasoned homeowner looking to move up to a bigger or better house, how you have managed your consumer credit rating can have a real impact on both the amount and terms of your next mortgage.

Naturally, if you have kept your credit use reasonable and always paid your bills on time, you will most likely have very few difficulties obtaining a mortgage loan. But what if you are one of the many Americans whose credit report is less than perfect? Contrary to popular belief, it is not impossible to obtain a mortgage with an imperfect credit rating. After all, mortgage lenders are in the business of providing loans, and have it in their interest as well as yours to find an appropriate way to finance your home purchase.


Credit Doesn't Necessarily Have to Be "Perfect" to Be Good

In the case of a single bad mark on an otherwise good credit history, many mortgage lenders will simply ask for a written explanation of the late payment. If the explanation is reasonable and believable, many lenders will overlook the isolated problem-especially if it occurred some time ago and your credit has been good since.

Indeed, as far as lenders are concerned, the most important time period in your credit history is just the preceding year or two.

According to guidelines established by the Federal National Mortgage Association (Fannie Mae), indicators of good credit do include some leeway for occasional late payments. Thus lenders will look at:

  • Revolving credit (e.g., credit cards), which should show no payments 60 days or more late and no more than two payments 30 days late;
  • Installment credit (e.g., an auto loan), which should show no payments 60 days or more late and no more than one payment 30 days late;
  • Housing payments (e.g., mortgage or rent), which should-not surprisingly-show no late payments (this can be proven by the payment history from a mortgage lender or by the borrower's canceled checks for the past 12 months).

Credit Scoring Broadens Scope of Lenders' Considerations

As credit scoring in mortgage loan decisions has become more sophisticated, lenders have also begun looking at other factors in your credit history as well. They might be concerned if your credit cards are "maxed out" (indicating possible future difficulties in managing debt and making payments) or, conversely, if you have large lines of credit available (that you could at some future time run up into unmanageable debt).

Some lenders will also look at how many inquiries have been made into your credit report recently, interpreting a large number of inquiries as a sign that you have applied for a large amount of credit lately. Applying for numerous lines of credit might indicate that you have been turned down by several other lenders or that you are in the process of accumulating new credit accounts which might leave you with too much credit available to be a good credit risk.

"Compensating Factors" Can Make a Difference

Credit scoring can also work to your benefit, helping to overcome potential problems like a high debt-to-income ratio or a slightly imperfect credit past. Scoring also considers "compensating factors" that Fannie Mae guidelines indicate might justify some degree of risk to the lender. These compensating factors include:

  • A large down payment;
  • An energy-efficient property (e.g., with up-to-date heating and power systems);
  • Previous large housing payments (such as high rent), which show the borrower's ability to channel a larger-than-normal proportion of income to payments;
  • A history of good credit and the potential to accumulate savings in the future (despite a current low net worth);
  • The likelihood of career advancement and earnings increases due to strong education or job training (this is particularly helpful to young borrowers who carry student loan debt);
  • A substantial net worth (despite current low earnings).

Knowing about these compensating factors-and which of them are at play in your own situation-can help you to get the loan you need for the home you really want. But you also need to know what your credit history looks like on paper to be able to optimize your borrowing ability.

For example, you may have cut up a credit card years ago, but never bothered to actually close the account. This account shows up on your credit report as available credit, which lenders may think adds to your risk. The time to close this unused and unnecessary account is before you apply for a mortgage.

In addition, you will want to be confident that the information in your credit report is accurate. Inaccuracies in your credit report-or, worse, the damage done by credit or identity fraud-can seriously impact mortgage lenders' likelihood of offering you a loan.

Reviewing Your Credit Report Puts You In Control

Many financial planning experts recommend checking your credit report on a regular basis in order to keep tabs on the information placed on it. Routine checking on your part allows you to stay on top of what credit grantors-including mortgage lenders-will read about you when they check your credit history, and enables you to correct any inaccuracies and catch fraud before these problems impact your mortgage loan. Disputing inaccuracies can take up to 30 days to resolve, so taking care of them well in advance of applying for a mortgage is also important.

The information provided by your credit report can be invaluable in understanding your credit rating as mortgage lenders see it, enabling you to correct inaccuracies and know best how to present your correct credit history and circumstances in order to get the mortgage you seek.

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