Coming Clean with Credit
By Sally Anderson for MSNBC.com

Credit can be a wonderful thing, but, like eating cake, too much of a good thing can backfire on you. And for wannabe homeowners, loan approval relies more on your history of debt repayment than on your income or savings.

How do you know if your credit history is healthy? First, don't rely on guesswork. Order a copy of your credit record, preferably three months before applying for a loan. You'll see where you stand and have time to clear up errors, which are a common finding, on your record.

How Is Credit Risk Measured?

In today's lending market, most credit reports are automated, relying on a credit "scoring" system that analyzes about 100 variables to gauge the likelihood that the borrower will make on-time payments.

The information measured is gathered from retailers, public records, and sometimes credit applications and bank records. The score analyzes patterns over time, with more recent payment and debt habits holding greater weight. In the scoring system used by Fair, Isaac—the originators of scoring software—the main criteria and their approximate percentage of importance are:

·    Payment history (35%)

·    Amounts owed (30%)

·    Length of credit history (15%)

·    New credit—a warning of taking on too much debt (10%)

·    Types of credit in use (10%)

Lenders use these credit scores, which range from 400 to 900 points, along with information such as the stability of your income, your employment history, and the value of any collateral and liquid assets, to determine your credit risk.

Establishing Good Credit

These tips will help you establish and maintain a healthy credit history:

·  Open an account. The only stumbling block as serious as poor credit history is no credit history. To receive an automated credit scoring, you must have at least one account that's been open longer than six months and shows activity within the past six months. (On-time utility and rent payments may apply.) To establish credit, start by requesting a credit card from your bank; that will trigger other offers.

·   Don't go crazy on credit. Don't rush to open multiple accounts just so you can pay them off to raise your credit rating. Lenders see too many credit applications as a sign that your finances might be overextended. Applying for new accounts actually lowers your rating, since it lowers the average length of your account history—and, especially if you're new at using credit, it signifies risky behavior.

·  Pay down before saving up. Lots of savings or a high income may help you with a down payment, but if your credit history is questionable, you'll be lucky to reach that point. Lenders want a track record of responsible debt payment—that's how they make their living. Make a habit of paying your bills, preferably in full but always on time. Paying down debts also saves you more on each dollar by reducing high interest payments.

·   Minimize credit checks. Whenever someone requests your credit report, it appears in your credit history. According to Fair, Isaac, you can order copies of your own report from credit reporting agencies without worry; they even advise that you do this annually to check its accuracy, especially before a large purchase such as a house or car. But it could be a red flag if too many loan officers, credit card companies, or car dealerships are requesting your credit record.

·  Don't take it to the limit. Lenders are wary of too many cards, but a bigger warning sign is even one account that's maxed out; they see it as a sign that you're overextended. The ideal is to use only one or two cards with medium balances that you pay on time (remember, punctuality is more impressive than full payments). On the other hand, if your debts reach the limit on one or two cards it's better to redistribute lower balances over several accounts.

·  Hold off on purchasing big "toys." Lenders like low debt, so unless yours is very low, hold off on charging a car, a boat, appliances, or large furniture until after you've closed on a new house. 

Cleaning Up Your Credit

If you have credit problems, make improvements before applying for a loan. Even if your history includes a bankruptcy or foreclosure, following these tips can polish up your record enough to help you qualify for a future loan:

·   If you've made late payments in the past, take six months to a year and make every payment on time before applying for a loan.

·   Use cash whenever possible, and stop charging.

·   Use secure savings to pay down high debts vs. saving for a down payment that may never happen.

·   Lower the balances on all credit cards; as they're paid off, write to each company canceling your account until just one or two remain.

·   Pay down installment loans such as car payments.

·   Don't open any new credit accounts.

·   If you've had a good credit history for seven years (the period considered in scoring), but it was damaged by extenuating circumstances, write a 100-word explanation to file with your loan application.

·   For serious credit problems, ask a credit counseling center about signing up for a home buyer's payoff program and apply for a loan only when you're nearing the end of the program.

Still turned down?

If your lender turns down your application because of poor credit, ask for precise reasons and for a copy of your Residential Mortgage Credit Report. If it contains errors, be sure the dates of facts in question are within the past seven years; anything older shouldn't be used to assess your credit risk. Advise your lender of errors immediately, and contact the relevant agency or agencies below to request a new investigation of questionable areas. And be sure that credit accounts you've closed are noted as "closed by consumer." (Note: Closing an inactive account doesn't remove its history from your record.) Finally, ask your lender if you're a good candidate for "rapid rescoring"—a growing trend in which a local credit-reporting agency analyzes your report for inaccuracies and gives specific advice, potentially raising your score in a matter of days.

If you're turned down for a conventional loan because of credit problems, you can probably still qualify for a loan with a lender that works with people who have a B or C credit rating or a subprime lender, but expect a substantially higher interest rate. But be extremely cautious with "special" loans offered to high-risk first-time buyers—they often demand impossibly high interest rates or promise future refinances that never happen.

Even with a great credit history, remember to review your credit report annually or before making major purchases. Below are the three credit bureaus that provide credit scoring to lenders:

Experian: 888-397-3742 or www.experian.com
Equifax: 800-685-1111 or www.equifax.com
Trans Union: 800-916-8800 or www.transunion.com