Rental Property Investor · Palm Bay, FL · Member since 2009 · 511 posts · 290 votes
I have someone who is trying to qualify for an FHA Loan. He has a credit score of 680, but has 5 credit cards, most of them close to their limit.
He is coming into some money and can pay down some cards, and asked me how he should do it so that it helps his credit score and looks good for him to qualify for his FHA Loan. Here's the two options I came up with for him with the amount of money he has to do this.
1. He can pay 3 credit cards off completely, two with $800 limits and one with a $4,400 limit. The other two ($6,500 each) would remain at 95% of their limit.
2. He can pay off 2 credit cards completely, the two with the $800 limits, and he can pay down the other 3 to 50% of their limits.
Each one would be saving him money on monthly payments, with option 2 saving him more money. The way I see it, option 2 of having two cards paid off completely and 3 cards at 50% of their limit looks better than option 1, but this is not my area of expertise, so I come here to the experts.
50% is the first benchmark to help pop the scores up, but if he can get them below 35% that is even better. IF he can't do that, have him pay each card to just below the 50% mark
Have your client to pay down his credit card debt to 35% of the credit limit and keep the balance there. You do not want him to pay off his cards completely. That will boost his score drastically.
To me the numbers you are providing aren't adding up. Option number 1 implies that he's getting $6000 (800+800+4400), and has a total of $19,000 in debt (800+800+4400+6500+6500).
Then in option 2, you're saying that he could pay off 800+800, plus half of 4400+6500+6500 = $10,300 total - not $6000
50% is the first benchmark to help pop the scores up, but if he can get them below 35% that is even better. IF he can't do that, have him pay each card to just below the 50% mark
If he has a 680 he should be able to qualify for an FHA loan without playing with his credit cards. That is depending on what his Debt to Income ratio is and Assets. Advising without really knowing the whole picture could mean less than effective strategic advice. Additionally, FHA and Agency eligible loans are not based on credit score, it is based on credit history. That said in underwriting the score does have an influence but as much as the common public tends to think. Credit score is a function on manual underwrite loans and were common in the sub-prime market.
Higher credit scores are a function of the good use of credit. Under this premise, maxing out credit is not a good use of credit. As has been stated if you "close" a credit account you actually remove the total credit available in the profile. So if your friend pays off and closes his $800 card he now has $800 less in credit available.
I have not personally heard of the 35%% level being some substantial benchmark but certainly 50% is. Also, understand not all credit companies report to the agencies on a monthly basis, although many do. So him paying down a card might not show up for 2 months. Additionally not all credit companies report to all three credit bureaus. So not having an understanding of what each repository is reporting on him at could result in misguidance.
Additionally, it is not posted just what repository (credit agency) is reporting the number you listed. So we don't even know if that is the lowest score out of the three or the highest.
My suggesting is, no offense, stop giving suggestions. Let your friend go sit down with a mortgage officer and review his eligibility before he does anything. Within a 15 day span a consumer is allowed to shop multiple mortgage credit providers in order to ensure he gets a good loan. So just in case, the myth about pulling credit a couple of times is false. Certainly, it is a good idea to start the mortgage shopping at a solid mortgage provider like a bank or credit union, etc.
The credit algorithm is not disclosed by credit agencies but has general guidelines.
Over 75% usage of available balance will hurt your score.50% usage is not a negative or positive but a neutral in the scoring system. So if you pay down to 50% it will take a negative to a neutral and improve the score.
33 to 35% and below will positively affect your score.
If they have any old collections or judgements etc. DO NOT and I mean DO NOT contact those creditors or make partial payments to them.What that will do is REFRESH and old negative account and make the credit score take a nose dive.
It is true it takes usually 1 to 2 months to update changed results in the scoring model.If the buyer has a time sensitive loan issue the lender can do what is called a "rapid re-score" with the credit which will update the credit report score much faster but costs money.
In addition to paying down the cards your buyer can also request a credit line increase on all the cards.If 3 out of 5 or 2 out of 5 increase the limit that will help bring down available credit percentages to used credit even more.
Even though the buyer is at 680 they want to try to get the score up higher.You do not want to be right at where the score requirement is and then something happens and you are off by a few points.
Do not close credit lines.One of the scoring criteria is length of active credit history in good standing.If the buyer has 5 cards and 3 are 2 years old and 1 is 1 years old and the last one is 4 years old then you have a 4 years history.
If you close out the oldest one your credit history in good standing has dropped to 2 years now which affects the scoring model.The buyer should stay away from big purchases cars,furniture,appliances,vacations,weddings,etc. until AFTER they have closed on a house and moved in.
Those types of purchases are much more lenient on debt ratios than house loans these days. The lenders right before closing will pull credit again to see if anything has changed.
This gets the buyers in trouble as I have seen it happen where the buyer is approved to close on a property and closing is a week from now.They think it is locked in so now they can go buy all this stuff and then the lender checks and now it's a no go.Remember do not do ANYTHING with these types purchases until AFTER closing.
Thank you for your replies and the information you provided....the reason I posted this question was also to learn about this myself, so that I can have some knowledge. I know got some knowledge....and that is that this is complicated and I don't want to know about it! Haha :)
I'll be taking Dion's advice....staying out of it and having my friend go to a mortgage broker...
Payoff and keep balances below one third (.33) of the maximum credit line. Pay the highest balances first and then the highest rates. While from your own standpoint, you should pay the highest rates first, but having a higher rate is not a credit score issue, so to establish better scores, knock out the high balances first to get to one third and then work on the highest rates.
You may think you pay a card down to 1/3 but if you go to exactly 1/3 each month you'll have accrued interest and the average amount due will then be above 1/3, so allow for accruals. Staying at 20% is better and better yet is to payoff as amounts become due.
If he was my client I would look to purchase 2 or 3 Authorized User Tradelines with High Limits 5%-10% balances and Pristine Credit history 5-15 years.(raises your score by 35%)
By adding another $25-$60k in available credit you offset his utilization rate (raises your score by 30%) and in turn will boost his credit to well over a 740
The only down side to this option is that you will have to wait about 30 days for the accounts to post.
If he is looking to get a house ASAP he might not want to wait, but with scores over 740 he would be able to qualify for the best FHA rates available or even conventional financing.
This method is tried and trusted.
The cost he would be looking at spending is around $1600 for 2 or $2400 for 3 Tradelines
