In some ways, a bankruptcy isn’t the worst thing that could happen to your credit. Since you can only file bankruptcy every 7 years, lenders will know that for at least another 7 years you can’t legally escape your financial obligations. Unfortunately, they do take note of the fact that you may have gotten over extended in the past and they may be reluctant to qualify you for an amount that someone with better credit may get. To get the best rate possible after a bankruptcy, you will have to wait 3 – 4 years. Also, expect to put down a large down payment of about 20% – 30%. The lender wants to ensure that you are financially invested in the house and that you will also incur heavy losses if you default.

In the case of a foreclosure, you may qualify for an FHA loan after as little as two years. FHA loans require a minimum down payment, sometimes as low as 3.5%, so it may be worth it to wait a couple years before realizing your dream of home ownership. Before the housing melt down started, you used to be able to get mortgages for 100%  of the homes value from some banks and sub prime lenders, understandably this has proved to be a very risky venture and these loans are no longer available for people needing a bad credit mortgage.

Your FICO score is the main determining factor in the interest rates you will get.

 This chart is an example given by FICO as indicative of the impact your FICO score will have on your credit. 

For a $216,000 house with a traditional 30 year fixed-rate mortgage you can see how your payments will increase as your FICO score decreases. An interest rate difference of even 1% over the course of a 30 year mortgage will add up to potentially thousands of dollars as you can see in this example.  The home buyer with an excellent FICO score of 760-850 will be paying $219 a month less than the buyer with a score in the 620-639 range.  You can begin to see how quickly this adds up, in this example the bad credit mortgage will cost $2,628 more per year.

Another possible option for a bad credit mortgage is to rent to own or find a home with seller financing. With a rent to own, you would typically pay a higher rent with a percentage of the rent going towards a down payment. After a set period you may have to qualify for a traditional loan if the seller isn’t financing so you need to be sure that you can meet the terms of the rent to own agreement or you may lose all or part of your down payment. In the case of seller financing, it is exactly what it sounds like, the seller acts as the lending agent. This can be a beneficial arrangement for both the buyer and the seller as there are no middle men such as realtors and banks driving up closing costs. With seller financing, because expenses are kept low, the loan conditions can be quite favorable for a buyer. In both of these examples you are still advised to hire an appraiser and an attorney to review the paperwork to make sure you understand all the conditions outlined in the sales contract. 

Without a doubt, the best way best possible to get more favorable loan conditions is to wait it out for about 3 years and work on improving your credit history and your FICO score. But even if you don’t want to wait, it is good to know that you still have some options available to get a bad credit mortgage.

FICO rates you credit score on 5 different criteria, weighing each according to what is considered to be the most important. This pie chart is from the FICO website and shows you exactly what your credit score is based on:

So, you can see that the areas where you would get the biggest bang for your buck are in the areas of payment history and amounts owed. These two areas alone account for a whopping 65% of your credit score so this is a good place to start your credit repair plan.

The Two Main Places to Start Your Credit Repair:

Payment History – From now on, you need to pay every single bill on time. Even if you are a “little late” this can have a bad effect on your credit, so you need to resolve to start paying all your bills in a timely manner or suffer the consequences.

Amounts Owed – You need to seriously reduce this amount. This is the amount of overall debt you carry; it includes mortgages, car loans, student loans, credit cards, business loans, and personal loans. Another important part of this Amounts Owed section is the amount of credit you are using versus the amount of credit you have available. If you have all your credit cards maxed out, this will reflect very poorly on your overall credit score, so you need to work on reducing your debt.

This may not be the article on fast credit repair that you were hoping for, but anyone selling fast credit repair is selling false hope. You can improve your credit score, you can get better loan rates, and you can qualify to buy a home, but it won’t be fast, it will take time.

Although some of these credit restoration companies are legitimate and may offer you some help in improving your credit, you need to be aware that some of these companies are scams, so you need to do your homework. You should check out the credit restoration company with the Better Business Bureau (BBB), verify that the company is licensed, and I’d also do a quick Google search to see if any customer complaints or lawsuits pop up. I also would strongly caution against paying exorbitant fees to use a credit restoration company, after all, you already have bills you haven’t paid, why accumulate more debt.

I think the main reason people seek out credit restoration companies is that the average individual feels that credit repair is beyond their skill set and this is usually simply not the case.  A credit restoration case worker is simply more familiar with how the system works, but this doesn’t require a special skill set, it just requires tenacity. Most people can set up their own credit restoration plan, put it into motion and achieve the same results they would using a professional company. A lot of people go with these credit restoration businesses, because they simply don’t want to do the work, or feel that they don’t have time to do the work involved in dealing with creditors. It involves a lot of time on the phone, letter writing, and more time on the phone.   

In a nut shell, what you need to do to start improving your credit is simply pay your bills on time. Every time you pay a bill late, even a day late, this is a negative mark on your credit. You should also begin paying down the debt you owe, as a big part of your FICO score is determined by how much credit you have available vs. how much credit you are using. For example, if you have a credit card with a $5,000 limit and you have it maxed out, this is not as good as having a $5,000 limit and you have only charged $400. You also do not want to cancel any of your existing credit cards because this can affect both the equation mentioned previously, but also part of your FICO score is based on the amount of time you’ve had credit. So, canceling a credit card would reduce your amount of credit available and the amount of time you’ve had this credit available, so this may negatively impact your credit.

Another thing to consider since the length of your credit history plays a part in your overall score is to occasionally rotate your credit card use. Every now and then, buy something with an older credit card and immediately pay it off. This will effectively “age” your credit and boost your credit.

If you get to the point where you are so over your head that you can no longer pay your debts then you may have to consider bankruptcy as an option. Due to the current economic climate, this no longer has the stigma that it once did. This will effectively remain on your credit report for up to 10 year, but within 2 years you could qualify for a new home loan providing that you meet all the other criteria such as work history and current good credit use.

So, credit restoration is possible, but consumers need to realize that there is no quick fix. With a plan and deliberate action, you can begin to slowly raise your credit score. The process takes time, but you should see a small yearly increase in your FICO score for each year that you show a responsible use of credit. Although bankruptcy can be an emotionally and ethically hard decision to make, for some people it will prove to be the right decision. With upside down mortgages and no employment, even a credit restoration company can’t work miracles.