When
it comes to credit, sometimes the largest challenge is the most
difficult to surmount: we simply don’t know what we don’t know, so our
assumptions and inaccurate beliefs run wild and free through our mental
real estate. Most of the time, there’s no harm; following finance
fundamentals like paying every bill on time, every time, keep us out of
credit danger zones.
But when it’s approaching the time to buy, refi or
even rent a home, relatively small credit score differences can stop
you from getting your dream home, and can cost (or save) you thousands
of dollars in interest over the life of your loan.
If
you’re at a time in your life where it makes sense to invest some time
and effort into optimizing your credit score, here are five common
credit myths we’d like to help you bust without further ado:
Myth #1: Having lots of cash, a great income, or tons of equity, makes your FICO score less relevant.
Fact: No
matter how much cash you have, if you want a mortgage, you must meet
the lender’s FICO score guidelines. Of course, if you’re flush with
cash, it should be relatively easy to make your monthly payments on
time. But if you have come into cash relatively recently or you’re coming
off a rough financial patch, lenders don’t not
look at your credit score on the theory that your other assets diminish
your credit riskiness. Most lenders want nothing more than to avoid
having to foreclose on a home, even if the homeowner has other assets.
And the best predictor of whether you’ll default on a loan in the
future is how you’ve handled your credit in the past, so your credit
score will drive whether you qualify for a home loan and what interest
rate you’re charged, no matter how much you make.
Two
exceptions: if you buy a home with all cash, or take a hard money loan,
which usually requires a much larger-than-average down payment and
interest rate, you might be able to bypass credit score scrutiny, but
you’ll pay for it.
Myth #2: Having no debt or no late payments means you have great credit.
Fact:
Financial responsibility and good credit are two different things.
Your FICO score is meant to be a measure of your responsibility when it
comes to managing debt, as proven by the fact that you have credit
accounts, use them regularly and don’t abuse them.
Having
no credit accounts or debts doesn’t give you good credit - it gives you
no credit. And on the other end of the credit usage spectrum, being
maxed out on various credit accounts all the time, submitting lots of
credit applications and other credit moves that indicate you may abuse
your credit can actually depress your score. Best practice is to have
several credit accounts (student and car loans count!) that you actively
and responsibly use on a monthly basis.
Tip: FICO gives a top score to
accounts with balances that are 30 percent of the credit limit, so if
you can keep your credit card or loan account balances at or around that
mark, even better.
Myth #3: Checking your own credit score in advance prevents surprises when you apply for a mortgage.
Fact:
Your mortgage originator (broker or banker) must pull their own
version of your report from their own provider, and it might have a very
different score, rating scale or even different line items than the
free or paid report you pulled online. This is why it’s imperative to
start working with a mortgage professional as early as possible - a year
in advance is not overkill - so you can detect any errors or issues and
get their recommended fix in the works with plenty of lead time.
Myth #4: If you’ve had a foreclosure or short sale, your credit report will be damaged for 7 years.
Fact: Derogatory
credit items, like late mortgage payments, foreclosures and short
sales, appear on your credit report for 7 years, but your credit score
can be rehabilitated enough to buy a home or obtain other credit in less
time, depending on your circumstances. Your post-short sale or
foreclosure waiting period depends on a number of things, including
what type of loan you’ll be seeking to buy your next home with, how much
cash you’ll have to put down and whether there were any extenuating
circumstances involved in losing your home in the first place; some
loans allow for an immediate purchase, others require a waiting period
of
2, 4 5 or even 7 years after the loss of a home.
Of
course, your FICO score is also a key criteria in a post-home loss
“buy,” but interestingly enough, the length of time it takes to get your
FICO score back up depends on how high it was beforehand. Earlier
this year, the New York Times reported that it would take a consumer
with a 680 FICO score three years after a foreclosure to bring their
score back to that level, while it might take someone with a 780 FICO
score (near-perfect) seven years for full score recovery.
And keep in mind that as your foreclosure or short sale ages, its impact on your score will decrease, too.
Myth #5: Short sales have much less impact on your credit score than foreclosures.
Fact: Hear
ye, hear ye - short sales and foreclosures have the same impact on your
credit score, according to the FICO folks themselves. (The only
exceptions are for short sales or deeds-in-lieu of foreclosure where the
property was not upside down, which are few and far between, if they’re
not just a real estate urban legend!)
However,
the number of missed payments you had before your home was lost to
foreclosure or short sale might weigh on how gravely injured your FICO
score is in the process. At the going rate at which banks are
foreclosing on homes - clocking roughly 2 years of missed payments
before a home is repossessed - your FICO score could take an even
greater hit than if you were able to divest of it via a short sale in 1
year’s time.
Call
us today to get ready for the New Year's Home purchase. Let us hep you
get things in place and answer any questions you may have about
purchasing your next home.
-TRG-
By Tara-Nicholle Nelson |
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