Typically, a person with a bad credit score is in this position because they lack structure in their life. There are, of course, cases where unplanned health or employment complications are to blame, but for the most part, these are individuals who lack the discipline to pay their bills on time or curb their spending. This is your opportunity to be the "knight in shining armor" that provides them with a simple roadmap to get back on track.
Let's take a look at some examples that can help to quickly improve less-than-perfect credit scores for the potential homebuyer:
Let's say we have a borrower who needs to do a stated income loan to buy the home they want, but they have a credit score of 664. They have a concentration of credit card debt on one card; let's say $17,000 on a card with a $20,000 limit. At the same time, they have four or five additional credit cards, all with a zero balance. I would advise the borrower to distribute the debt over the cards that are available to work with. This changes the ratio of debt to available credit, and can cause their credit score to pierce through that magical threshold on our chart (from Part I of this series), and put them in the 680-699 category of having good credit.
Another thing to take into consideration in a case like this is what percentage each of the five factors measure in the resulting credit score. Let's say we have a borrower with a credit high (the maximum debt allowance on all cards, combined) of $20,000. They have one card that is used for business purposes that is pushing the limit. I would advise the client to get two new cards, each with a $5,000 limit, and once again, spread the debt out over the cards leaving a 30% margin of available credit on all the cards. This will affect the factor of credit history, but this specific factor only affects the overall score by 15%. The big difference, once again, is the resulting impact on the credit balance factor, which has a 30% influence on the overall score and can cause the overall calculation to pierce through the next level on our chart.
Conversely, the borrower should be advised not to close any existing credit card accounts, even if they are at a zero balance. Some people think they are doing themselves a favor by having fewer cards, and they lose out on the credit history factor. Even if the borrower does not have a good rate on an old credit card, they are rewarded for having the long-term credit history, and from time to time they should make a small purchase to keep the account in an active status.
These are just a few examples of what borrowers can do to improve their credit score when they consider buying a home. If they are disappointed by the fact that they cannot get the A-Paper loan up front, I would continue to monitor rates and their specific loan scenario on an ongoing basis and advise them when they will have a chance to turn this situation around. The new mortgage debt will temporarily drop the score, but once the first payment registers as "paid," the score will begin to go up again and eventually present the opportunity to refinance at a lower rate.