The Money Question: How to Fix Terrible Credit

Because of some irresponsible behavior in the past, I have terrible credit. My husband and I want to buy a home in a few years. How do I get my score up before we apply for a mortgage?
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The good news is that no matter how bad your credit is, it will get better if you're financially responsible from here on out. Even extreme problems, such as bankruptcies and tax liens, stop harming your credit after 10 years. And while it takes seven years to get fully clear of most monetary mistakes, like that string of missed credit card payments from college, the situation improves gradually over that span. In general, three years is enough to turn a marginal credit rating into a good one.

Get the Whole Picture

To find out your credit standing, you need to consider separate elements. Your "credit report" is a financial history showing what you've borrowed, how responsibly you've paid it back, and any bankruptcies, judgments, or liens you've faced. Three agencies (TransUnion, Experian, and Equifax) compile this information, and you can see each of their reports for free, once a year, by going to annualcreditreport.com. Eyeball all of them for overlooked debts you need to pay off as well as out-and-out inaccuracies. (For those you'll want to contact the lending institution and correct the mistake long before you apply for a mortgage.) The tool lenders use to gauge mortgage worthiness is your "credit score," a numeric rating that ranges from 300 to 850 based on information in your report. That score determines whether you will be given a loan and at what interest rate. (You can order your score at the same website for about $10.) Lenders' requirements vary, but for mortgage applications, a score between 600 and 750 is generally the normal range; one over 700 is good. The higher your score, the lower your interest rate is likely to be.

Clean Up Your Act

With every month of good history added to your report, your score will rise. So, effective immediately, never miss another payment on anything -- even if you only pay the minimum. That means every bill you owe, including credit cards, rent (now included in some credit reports), utilities, cell phones, and medical bills. Try to beat the due date to avoid late fees and interest, but don't stress if you're a few days late. A report doesn't go to the credit agencies until a bill is 30 days overdue.

Pay Down Your Debt

Although you're busy saving for a down payment (generally at least 20 percent of a property's purchase price), try to pay down as much debt as possible. A big component of your ability to get a mortgage is your "debt-to-income ratio," so every penny you pay back (and every salary increase you get) makes you more credit-worthy. Eliminating credit card debt also improves a key credit-score factor: your "utilization ratio." Essentially, this is the percentage of your available credit that you've actually tapped. Ideally, no card should carry a balance greater than 30 percent of its credit limit, so focus on paying on high-balance cards. And if you can, open a couple of new cards. It sounds counterintuitive, but each account will come with a new credit line and therefore will raise your total available credit. The catch? You must use the cards lightly and never carry a balance. That way, your utilization ratio will be more favorable overall.

Keep Charging

Understandably, many people with credit problems switch to a debit card to protect themselves from further mishaps. But that's precisely the wrong move since the only way to improve your credit is to use it -- responsibly. Pick a card or two, charge routine purchases, like gas and groceries, and pay off entire balances each billing cycle.

Take It Easy on the Home Stretch

Six months before you begin househunting, check your credit score again. Assuming you're on reasonably solid ground, don't apply for new credit cards or even close old accounts, since both these activities may temporarily lower your score by a few points. As long as you can show six months of calm, uneventful credit use, mortgage lenders will see that you've got exactly the kind of financial stability that they're looking for.

Maxine Sweet is vice president of public education at the credit-reporting agency Experian. She holds an MBA from the University of Arkansas in Little Rock.

 

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