Don't let delinquent debt keep you from getting a mortgage
Erica Sandberg is a prominent personal finance authority and author of "Expecting Money: The Essential Financial Plan for New and Growing Families." She writes "Opening Credits," a weekly reader Q&A column about issues for people who are new to credit, for CreditCards.com.
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Dear Opening Credits,
When diving into my credit report, my Realtor mentioned that collection accounts on my records would prevent me from getting a loan. For the past few months, I have been focusing on getting my score down. My wife and I would like to try and do whatever we can to qualify to buy a house within a year or two. We both have stable jobs, and combined, we will make about $105,000 this year. The major collection debt (over $1,000) we have is anywhere from 5 years to 6 years old and combines old medical bills and credit card bills. The other collection debt we have is under $1,000; I will pay off within the next month or so.
My problem is, we have the means to pay off these collections within the year, but I do not want to have to deal with the collection agencies because I just do not trust them. Also, I do not want to get into a credit counseling program that consolidates all of my debt (current good-standing credit cards and collection debt) because I hear it looks worse on a credit report than bankruptcy. Can you provide any guidance or direction on any actions I could take to improve our credit so we could get a house with a year or two?-- Mike
I assume that you meant getting those FICO numbers up, not down, as higher credit scores indicate less risk to the lender. In this current economic environment, most financial institutions are looking for borrowers to have scores that are at least in the 700 range.
While you may be handling your present accounts well at the moment, I have no doubt that those in collections are deflating your scores. So before I tell you how to improve them, I want you to pretend for a moment that you are a mortgage lender ...
A stranger walks in your door asking for a home loan. All you have to go on to make an objective and smart decision are his credit reports and scores. However, when you pull his reports, you immediately notice evidence of unpaid debts and some pretty low credit scores. Bear in mind that you don't know his background. Sure, he may have experienced some medical issues that resulted in high and unpayable hospital bills, but all you can see are a couple of unsatisfied balances. Even if the stranger offers a good reason for the arrearage (assuring you that he wasn't just charging recklessly), how much would it really matter? He's not a friend or family member who you want to help out; he's an unfamiliar person with whom you are potentially getting into a serious business deal. Your aim is to make money, not lose it. And based on his reports, he didn't repay his loans -- not just once, but at least twice. See where I'm going here?
Of course, that person you're assessing is you. Since I doubt you would hand over a significant sum to someone you didn't know if the situation were reversed, what you need to do is create credit reports and scores that sing your praises loudly. Yes, the lender will be looking at other factors, too, such as your income and length of employment, but those delinquent debts have got to go.
It looks like collection account No.1 is getting pretty old. The Fair Credit Reporting Act stipulates that this type of negative data will drop off a credit report after seven years from either the date of last payment or the date the account went into default, whichever happened first. So, since you say you're likely a couple of years away from purchasing a home, that debt would probably be deleted from your reports and not factored into your credit scores by that time anyway, whether you pay it or not. Therefore, you have a choice: Pay it, or let it age off naturally. If you pay it off now, your scores would increase, as a satisfied balance is always better than a delinquent one.
Regarding collection account No. 2, it's still quite young and should be dealt with swiftly. As it's just about $1,000, my recommendation is to pay it in full as soon as you can. You express concern about dealing with collection agencies, but if you are intending to send them a check, just be sure to put everything in writing. (Here are some sample letters that might help.) Any agreements should be confirmed in writing and signed by a representative of the collection agency before any money changes hands. Send a letter to the collection agency stating what you are going to do and that you expect them to update your credit files with the accurate "zero balance due" in their next reporting period. Send the letter via certified mail, just to be safe, because we all know that sometimes mail gets lost.
As for credit counseling, know that opinions vary about how debt repayment plans are perceived. For some lenders, it's a nonissue, but others take a more pessimistic stance. In the end, though, it doesn't look like you need it. You seem to have the ability to cover the delinquent accounts and are current on the rest.
So, Mike, by taking care of those collection accounts, whittling other balances down and maintaining a perfect payment pattern, your credit scores and history will be far more attractive to banks than they are today. Do so and your goal of buying a home with a decent mortgage is a real possibility.
See related: See related: 10 things you must know about credit reports and scores, 8 legitimate ways to improve your credit score now, How to read, understand your credit report, How to dispute errors on your credit report, Free credit reports: How to get the one that's actually free, Know your rights: Fair Debt Collections Practices Act, 8 steps to picking a credit counselor
Erica Sandberg is a nationally renowned personal finance authority. She’s host of several financial web shows, and a frequent guest for media outlets such as Fox, Forbes, Nightly Business Report and NPR. Erica previously was affiliated with Consumer Credit Counseling Service and was KRON-TV’s on-air credit expert. Her book, "Expecting Money: The Essential Financial Plan for New and Growing Families," was published in 2008 by Kaplan Press.
Send your question to Erica.
Published: October 21, 2009