Your credit scores and payment history carry more weight in getting approved for a mortgage than ever. If you've had some rough times in your credit past but feel like the storm has cleared and you are ready to own a home again, you need to know how to present the case for why you are ready to get a mortgage.
1. The whole truth and nothing but the truth
If you have had major problems with your credit history in the last couple of years, my best advice is to wait to buy a house. Despite programs that advertise reduced timelines for allowing you to apply for a mortgage after a foreclosure, short sale, or bankruptcy, it is still difficult to get approved for them unless your credit score is at least 660 or higher.
If you really feel strongly about your case for another mortgage, then write out an explanation letter with details about what caused the major problems in your credit history and how those things have improved to the point that you think you are ready to take on a new mortgage now. Add in as much documentation as possible to support your explanation
One common reason for credit setbacks is a sudden illness that causes an extended period of unemployment. Providing an explanation and some doctor's notes about how you're on the mend and back to work will allow you to bridge the gap in employment and show that your circumstances have stabilized to the point where you will be able to pay a new mortgage.
2. The big credit bumps
Anything in your credit history involving the loss of a home due to inability to pay a mortgage will present the biggest challenge in the mortgage application process. Foreclosures, short sales, and late mortgages payments in the last two years will make it very difficult for you to get approved, even if you have a large down payment and lots of income. This may seem unfair, but lenders view anything related to default on a prior mortgage as a risk going forward. The more time that has passed since one of these major mortgage setbacks, the better.
If you currently renting, be sure to keep canceled checks to show how consistently you pay on time. This will help show a mortgage lender how well you are managing your housing expenses now.
3. Financial mismanagement or extenuating circumstances
In order to be approved for a new mortgage after a big negative credit event like a foreclosure or bankruptcy, you will have to prove to the underwriter that the credit problem was not due to your own financial mismanagement and that there were extenuating circumstances that caused the credit trouble.
The death of a household wage-earner and major medical issues are examples of extenuating circumstances that will enable a lender to consider approving a mortgage in a shorter time period, even after a bankruptcy or foreclosure. Extra documentation always has to be provided in these cases, as well as a detailed letter of explanation.
An example of financial mismanagement includes cases where a homeowner walks away from a mortgage because the house was so severely upside-down that there wasn't much hope of ever breaking even on a resale.
4. Collection corrections
There is a myth circulating in the mortgage industry that correlates paying off collections with dropping credit scores. According to credit.com, mortgage professionals often advise against paying off a collection, believing this will lower the debtor's credit score. The premise is that once the status of the collection changes from unpaid to paid, it will actually show up as a new collection. That is simply not true. The credit scoring system doesn't grant any fewer points for an unpaid collection than it does for a recently paid collection.
Sometimes the approval of a mortgage will not require collections of under $500 to be paid off, but in the long run, it's always best to have these paid in full or settled before you apply for a mortgage, because over time, your scores will improve with the collection shown to be paid..
5. Resolve those disputes
There is a credit "trick" whereby putting accounts into a dispute status actually prevents them from being fully scored on a credit report. That means a credit report with multiple collections that are in "dispute" status may show a higher score than a credit report with collections that are not in this status. However, while this trick may lead an automated underwriting program (like the ones used to prequalify buyers for loans) to grant an initial approval, it's a false positive. The disputes need to be resolved or taken off before you apply for a mortgage loan to eliminate any chance that the approval will be overturned because not all of the credit was being taken into account by the computer to begin with.
Final Foolish points
Despite all of the regulatory reforms in mortgage and credit lending, there will always be companies that come along and promise quick fixes and creative ways to game the underwriting system to get past credit issues or make it appear that you have less credit than you actually do.
Credit repair companies, in my opinion, are not worth the money when so many nonprofit credit-counseling alternatives exist. Most customers don't realize that they can repair their credit directly with each bureau. Calling Experian, Equifax, and Transunion yourself to fix errors or make your score reflect paid-off collection accounts sooner will produce quicker results than paying a third-party company.
I can't emphasize enough how important it is to tell your story and provide as much detail about what happened and how things have changed for the better. If you don't get approved at first, ask your mortgage professional for an idea of what you'll need to do to get approved in the future. Often the only thing standing between you and an approved mortgage is a little more time since the credit challenges occurred.
