A bad credit history could mean no mortgage. But just how far back do lenders look? Does one mistake scar you for the rest of your life? Luckily, it probably doesn’t. Unless of course, you don’t pick up the pieces and improve your credit moving forward. Here we will discuss how a bad history can hurt you. We’ll also discuss what you can do to help your case.
A Bad Credit History
Just what is a bad credit history? It’s all relative. What one lender thinks is “bad” another might overlook. So there isn’t a concrete answer to this question. What you should focus on instead is the big picture. If you have negative credit reporting and a high debt ratio or a spotty employment history, then you’re a high risk. On the other hand, negative credit accounts in the past combined with improved credit and other stable factors may not mean high risk.
Just how far back do lenders go, though? It depends. Generally, they say 1 year. If you can clean up your act over the last 12 months, you should be okay. But, there are exceptions. They include:
- Bankruptcy – Each program has a different timeframe you must wait after filing for bankruptcy. The countdown begins on the discharge date. For example, FHA loans require a 2-year waiting period after a Chapter 7 BK.
- Foreclosure – Lenders also look at foreclosures for a loner period. Oftentimes it is slightly longer than a bankruptcy. For example, FHA loans require 3 years after the foreclosure sale before you can apply for a loan.
No matter the lender’s requirements, you must establish a positive credit history now. Every lender will look back at the last 12 months. If you have negative credit reporting during that time, it could hurt your chances. If you do obtain approval, you’ll likely pay a higher interest rate or closing costs.
Other Credit Issues to Watch
Negative credit history isn’t the only thing you must concern yourself with, though. Lenders will look at other aspects of your credit. Your score, for example, gives them a good idea of your financial responsibility. They will, however, look at other things as well:
- Utilization rate – How much credit do you have outstanding at the time of application? This makes a difference in your chances of approval. Let’s say you have $5,000 in available credit. If $4,500 of it is outstanding, you pose a risk to the lender. Instead, try to keep no more than 30% of your available credit outstanding at one time.
- Inquiries – Recent inquiries let lenders know you are trying to take out more credit. Because credit lines may not show up for a few months, this could limit your approval. Lenders need to know beyond a reasonable doubt that your debt ratio is accurate. With multiple recent inquiries, they may not be too sure of your debt ratio.
- Late payments – Late payments within the last 12 months greatly hurt your credit score. But, don’t discount the late payments from more than 1 year ago. Even if you improved your payment history, it may play a role. For example, a late mortgage payment may throw a red flag. The program may allow lenders to overlook it. But, a lender may not be willing to do so. They may inquire about the reasons to make sure it was a one-time issue and won’t repeat itself.
Increasing Your Chances of Approval
Even if you have a bad credit history, don’t think you can’t secure an approval. It just takes a few small steps to get back on track. Taking any of the following steps can get you started:
- Pay your bills on time – No matter how many late payments you had, start getting them back on track. Pay your bills before their due date, even if they have a grace period.
- Pay your balances down – If you have more than 30% of your credit balance outstanding, pay it down. Start with the smallest debt and work your way up. This way you can see progress right away. As the motivation builds, you’re more likely to continue paying your balances down.
- Leave your accounts open – Avoid closing accounts you no longer use. Even though they sit untouched, they help your credit score. A part of your score is the age of your accounts. Newer accounts bring your score down. If you leave an older account open, it helps to increase the average age of your accounts. This often helps increase your credit score.
Have Explanations Ready
No matter what happened in your credit history, have an explanation. What one lender might overlook, another may want an explanation. By explanation, we don’t mean verbal. Lenders like to see things in writing. They also like to see proof of what you say.
For example, let’s say you were injured and in the hospital for a few weeks. During that time you couldn’t work. Your recovery took several months as well. You used up your benefits and paying your bills became difficult. You had a few late payments during that time, including your mortgage. You didn’t lose your home, but you damage your credit. Since then, you returned to work and got back on track.
You can write a letter stating the facts. But, including certain things like the medical bills from that time or even the medical report of your injury can help. The lender may also verify your story/dates with your employer. This just helps solidify your case and help the lender overlook the negative credit history.
Avoid assuming that your credit history is too far in the past to affect you. Lenders can look back as far as 6 years if they want. Many won’t, but the chance is there. Instead, make your current credit as good as possible and have explanations ready for the rest. Chances are history more than 12 months ago won’t affect you, but you can’t ever be too sure.