Rebuilding Your Credit In 12 Months Or Less
In today’s world of easy credit, it no wonder that more and more people are finding themselves with compromised credit due to outstanding collections or late payments. If you find yourself in this situation, it is important to address the accounts as best as you can and as fast as you can. Your goal is to prove to lenders that you have a "willingness to repay". Your credit file is one of the primary ways banks use to determine if they will lend to you and at what rates. You can see a breakdown at Fannie Mae’s website. Generally, the better an individual’s score, the better terms they get on the loan; and a score below 620 prevents that person from even obtaining a loan. Late payments or collections have a significantly negative impact on that image, which will decrease your credit score and, more importantly, decrease the likelihood that a lender will want to give you loan or line of credit. This is especially true with mortgage lending.
Breaking down your credit score
Lets breakdown your credit worthiness or credit score. There are five general rules that lenders use to identify credit worthy individuals:
Lenders want to ensure that the borrow has a clean payment history. This represents 35% of your credit worthiness or credit score.
The lender will verify that there are are no late payments within the last 12 months on any of your credit lines, both revolving and installment [more on this later]. The reason for this is that the last 12 months are usually the best indicator of a person’s willingness to repay. Keep in mind, however, that your credit will be affected, on a sliding scale, by ANY late payment within the last 7 years. Nevertheless, the most damage to your credit score will occur on late payments within the last 12 months. Therefore, your primary objective is to create at least a 12 month gap between the day your credit score is pulled and the last late payment that you had. This is especially true on your housing payment history.
Additionally, lenders do not want to see any collections on your credit report. When collections exist, it means that the lender of the original account has given up trying to collect the money themselves and have assigned the legal right to collect the payment to another company or agency. Collections, generally, must be paid off. However, there are oftentimes several good strategies to employ to clear them as well show later.
2. Lenders will check your current debts, which represents 30% of your credit score, to ensure that your credit utilization, or the ratio between the amount you owe and the amount of credit available, is less than 30% for your overall credit limit, as well as for each credit line. For example, if you have one credit card with a credit limit of $1000, you want to ensure that you don’t carry a balance greater than $300. If you have two credit cards with $1000 limits, than you want keep the balance on each card below $300 and the combined balance below $600. Carrying high balances – relative to the total credit limit – on several credit cards or lines of credit could indicate a greater risk of default. Thus, you want to keep your utilization below 30% and shoot for below 10%.
3. Lenders like borrowers with lengthy credit histories. The longer the borrower has had open credit lines, the more trustworthy they will look to lenders. Credit history is determined by the average length of history for all credit lines. Thus, when rebuilding your credit, you want to keep older credit lines open. Your credit history makes up 15% of your credit score.
4. Lenders will look at the types of open credit lines. Lenders want to see that the borrower has a mix of credit products, such as a mortgage, a car loan, a home equity loan, and one or two credit cards. This is considered healthier than having only several credit cards. Credit cards are consider revolving credit, credit that can be reused over and over again, whereas mortgages and car loans are considered installment loans, loans that have a monthly payment for a specific amount of time. Borrowers should strive to strike the right balance between types of credit they have. Your credit mix comprises 10% of your credit score
5. Finally, lenders will check the number of new credit applications or inquires in the last 24 months. Individuals who are attempting to open a large number of new credit lines are considered more risky. Individuals looking to apply for a new mortgage loan should stop applying for and / or opening up new lines of credit. 10% of a borrowers score is allotted to new credit applications.
With this information, you can make informed decisions that will help you make the most of your score. And the higher the score, the better your chance of getting the credit you need. Next, lets investigate strategies to increase your credit score within the next 12 months.
Fixing your score within 12 months
First, you usually start by challenging the validity of an detrimental item on the report. Under the Fair Credit Reporting Act (FCRA), consumers are allowed to review and dispute and correct information that is incomplete or inaccurate, as well as remove any outdated, negative information (seven years old or 10 years in the case of bankruptcy). The creditor has a certain amount of time (e.g., 60 days) to validate the disputed transaction. Frequently, the creditors can't/don't resolve the dispute in the allotted time, which results in the negative transaction automatically beging removed from your credit file.
Second, you will want to begin getting current on all your credit line payments. Remember, the most important is part of this is the last 12 months, so work towards having 12 months of on-time payments for all of your accounts.
Third, get your credit card utilization for each credit line as well as your overall credit line to below 30%. You’ll be in even better shape if you can get your utilization below 10%.
Fourth, stop opening and closing credit lines. You especially want to keep the oldest credit lines as they will help your credit history. Inquiries from new credit card applications, on the other hand, will temporarily hurt your score. One caveat to this rule is if you don’t have a good mix of credit types. It may be beneficial to get a secured credit card, that is, a credit card that is secured by a deposit, to develop and clean payment history.
And finally, work on clearing up collections.
If any of the information on your report, to include late payments and collections, you should first call the three credit bureaus (i.e., Experian, Equifax, and Transunion) and dispute the negative marks. If that doesn’t work, call the particular agency and demand they provide you with the supporting documentation from the original creditor for you to reference. They must provide it. If they can't, they must remove it.
Paying off outstanding collections
When applying for a loan, lenders typically do not want to see any collections on your credit report. This is where you’ll need to put on your negotiating hat. You wan to negotiate on how much you can pay and find out just how little it will take to make the collections agency go away.
The FIRST thing to ask is if they will "delete" the account once you've come to a collective agreement on payoff and successfully paid it. You want to get this in writing. The letter should state that upon receipt of $XXX, they will "delete" or indicate "paid in full or settled" on your account, and they will report the account as-such with the bureaus they report to. DO NOT pay until after you receive the letter. However, if after two weeks you have not received the letter, get back in contact with them and send the money because the debt needs to be paid in order to process your mortgage loan. You should only sen a personal check to ensure that your payment can be tracked and documented. You should also put "payment in full/settlement in full for account # xxxxx" in the memo line of your personal check you pay with. Also remember that there THERE IS NO SUCH THING AS A "PAYMENT PLAN" ON A COLLECTION. Do not establish payment plans, which are meant for longer term payoffs. This will prevent your ability to get a loan for your home. You should just pay it off in full to proceed with the loan processing
Negotiation strategies
Most collection agencies "bought" the right to collect on the account from the original lender. The right right was purchased for, literally, pennies on the dollar. For example, if you owe $1,000 on a collection, the agency may have paid $1.00. This comes with an agreement with the original lender to split any recovered money down the middle with the original lender. So, if you settle to pay $500 with the collection’s agency, the company makes $249 and the lender recovers $250 of what was originally owed. That is the main reason negotiating is so important: you may not have to pay full price to get the collection cleared up. There have been instances where $15,000 collections have been reduced to $3000. However, a generally rule of thumb is that the collections agency will reduce the payoff amount by 50%. All else being equal, this is a good deal. As with all negations, you should shoot for the stars, but always keep in mind that anything less than full price is a win. But, you should always remember that you owe them legitimately, and in the instances the negotiation does not go well, you still owe them. This does sometimes happen. So lets look at what you should do:
One of the best ways to negotiate with these companies is to be super nice, but firm. Most collection agencies are preparing to battle you. When you proactively call them and apologize profusely for having not paid it, and what can you do to help; often times the agency will be shocked. Remember, these people get hung-up on, cursed out, yelled at ALL the time. When you call them, act in a super nice manner, and are willing to pay, you greatly increase your odds of getting much of what you want.
Once you've come to an agreement of what they'll accept as a payoff, you should immediately ask is if they will delete the account once you've come to a collective agreement on payoff.
Ensure that you receive the agreement in writing.
Do not send them money until you get the letter, but only for a period of time, generally two weeks. The payment should be paid with a personal check with a statement under the endorsement line on the back of the check sating "The above signed hereby accepts this as payment in full for account # [insert account number] and creditor agrees to delete this account from the credit bureaus that they report to". If they send you a letter, it is not necessary to put this endorsement clause above on the back of the check, but you do want to write on the memo line of the check, "Payment for account #xxxx".
Do not start a payment plan. on a collection. Pay the collections off unless you have been given specific instructions by your lender stating otherwise. Either way, your objective is still to negotiate how much you will owe to decrease the payment plan amount.
If all else fails, use the ARMAGEDDON method:
Method #1 - If they won’t negotiate, tell them you are getting ready to file bankruptcy and this is their last chance to get money.
Method #2 - Hire an attorney to fight them.
Finally, if all else fails, pay them. Most collections are the result of an account that didn't get paid, and you want to pay on your obligations.
Conclusion
Having a good credit score, generally above 620, is critical if you want to receive a mortgage to buy a home or investment property. I hope that the strategies outlined above will put you on the quick path to drastically improving your score and helping you land a real estate deal with traditional financing. Conventional lending often offers the best terms for home-buyers and real estate investors.