Countdown to Clean Credit Before Applying for a Loan

It can take 12 weeks or more to tidy up your credit score to get the best mortgage rate with the least hassle. Get started with this countdown.

 Q: What are you aiming for?

A: High credit score = low interest rate. At the beginning of 2014, lenders required average FICO (i.e., mortgage-related) credit scores of about 724 or above for standard loans. Federal Housing Administration Loans required a 10% down payment for borrowers with credit scores of 579 or lower, and as little as 3.5% down for those with higher credit scores.

Q: How long does it take to clean up credit missteps?

A: The bigger the misstep, the longer it takes. Paying a routine credit card bill late can take three months to purge from your credit rating. Pay your mortgage 30 days late and it can take two or three years – the more you owe, the longer it takes for that ding to evaporate from your score.

Q: Is it better to wipe out small debts first or make steady progress on several open accounts?

A:  It always makes the most financial sense to first make progress with the highest-interest accounts. But many consumers find it more satisfying to completely pay off smaller debts, even if that isn’t the most financially efficient strategy, according to a recent report that ran in the Journal of Marketing Research. “Debt account aversion” is the academic term for going for small wins. The smarter strategy is to prioritize payments according to the interest rate on the card. Here’s how:

• Figure out (from the fine print that comes with your bills) the annual interest rate for each open account
• Prioritize the accounts with those at the highest rates at the top, down to those with the lowest rates
• Pay the most you can on each of the highest-rate accounts, paying the minimum on the lowest-rate accounts
• Tally your total progress each month so you can chart your progress in getting rid of your most expensive debt first

Get Going!

Collect your credit reports. You get one free report annually from each of the three major credit reporting agencies: Experian, Transunion and Equifax. Each agency tracks and calculates credit responsibility slightly differently, so it’s important to get each one.

Review the reports and your current credit card statements carefully. Look for:

• Mysterious charges on your credit card statements. Are you being automatically billed each month for something you didn’t order, or have tried to cancel? Are there charges for purchases you have returned or charges you are disputing? Are the lines for things you never ordered?
• Errors in your payment history. If you’ve paid on time, every time, is that what is recorded in your credit report?
• If you have paid late, were there extenuating circumstances that might persuade the company to erase the late charge?
• Are bills you have paid off, or situations you have rectified, still showing up on your credit report? Depending on the situation, you might be able to get fading black marks erased. It doesn’t hurt to ask.
• Accurate employment, identity and other basic information. Make sure your report is YOUR report.

Dispute a charge or request corrections.

Dispute credit card errors by following the advice of the Federal Trade Commission.  Have ready: your address, Social Security number, and date of birth. If you have moved in the last two years, you may have to provide your previous address. Different details for different credit reporting companies

You will also have to contact the appropriate reporting agency directly.

• Transunion
• Equifax
• Experian
• Corelogic

Next, it’s time to assemble your facts and show why what needs to be corrected, and why.

• Use this Sample letter to craft your argument.
• Make copies of the documentation (receipts and so on) and forward with the request.
• Keep documentation so you can resend the materials if needed.
• Mark a followup reminder on your calendar so you don’t forget to stay on it.
• Continue paying on time and monitoring your bill statements so you can be sure that corrections are posted.

Go for the goal: a mortgage

When you apply for a mortgage preapproval, your credit reports will be examined by the lender. If your score is high enough to win a rate that positions you to buy the house you want, minimize credit use until you close on the house.

But If you are turned down for a loan or get rate that you don’t think reflects your true creditworthiness, you can get a free copy of your credit reports to understand the basis for the lender’s decision.

Allow at least two months, and probably longer, for corrections and updates to be reflected on your credit report and score.

Accounts are updated monthly, so even if you pay off a card early, the credit reporting bureaus won’t hear of it for several weeks. If you charge up a storm right before the bills go out, it could be as long as two calendar months before you get and pay that bill and that payment is reflected in your credit report.

“Opening multiple accounts & charging too much can hurt your chances of getting a mortgage,” says Lynnette Khalfani-Cox, contributing editor to CardRatings.com and www.HSH.com.

Read more about how to rein in spending and credit to stay on course for buying your home.

About 10% of your credit score is based on inquiries about your credit, especially from lenders. Inquiries signal that you are about to 10% of your FICO score is based on new or applications for credit. A flurry of inquiries from lenders could drag down your score, especially if you open a fistful of new cards. (Inquiries that are not from lenders – such as a potential employer’s credit check and your own inquiries – do not affect your score.)

The official line, says Khalfani-Cox, is that a single inquiry might knock your score off by 5 or 10 points, but some industry sources say it could be as high as 35 points per inquiry. If you are concerned about hitting a certain credit score before applying for a mortgage, consider hiring a credit monitoring service. The monthly fee of about $35 can help you closely track – and immediately correct – any changes in your credit report and might be worth it if you are then able to get a mortgage at a lower rate, says Khalfani-Cox.

Once you’ve established a track for cleaning up and monitoring your credit, stay the course. Lenders look for consistency in how you handle your money, says Khalfani-Cox.

That’s even more true once you apply for a mortgage. “You don’t want anything in your credit profile to change, so you should have extra money in advance for deposits, moving costs and other fees,” she says.

And know that once you are approved for a loan and have a closing date set, lenders will take one last hard look at your credit reports and outstanding debt. “It comes as surprise to many homebuyers and then those anticipatory purchases — rugs, furniture, moving costs, subscriptions – can hurt,” says Khalfani-Cox. “They don’t realize that they’ve made a crucial mistake in adding to their debt load and might put their loan at risk because they’ve changed their debt-to-income ratio. You want everything to be as stable and consistent as possible.”