Thank you for your question about rebuilding credit after debt settlement.
Congratulations for signing up with Freedom Debt Relief and sticking with the debt settlement program. It is good to see that you were able to set your goals and meet them. Now, you are ready for your next goals: rebuilding your credit after debt settlement and buying a house.
In order to buy a house and qualify a mortgage loan, your lender will look closely at three factors, your credit history, credit score, and debt-to-income ratio.
Review these points to help you move from your present point of post-debt settlement to your goal of buying a house and taking a mortgage:
- Maintain a budget
- Rebuilding credit
- Buy a home - Take a mortgage
Call 800-998-7497 to speak with a Money Coach and set up a plan to build your credit score and learn how to avoid common errors that will prevent you from achieving excellent credit.
Maintain a Budget
The importance of making and maintaining a personal budget is obvious to anyone who went through a debt settlement program. Your budget is an important tool in rebuilding credit after debt settlement.
Leverage your experience, by making an effort to save money with the funds you have been using to make your debt payments. Your budget categorizes your monthly expenses allowing you to get a grip on your cash flow. Make sure that you track these financial ratios:
Debt-to-Income (DTI) ratio: Your debt-to-income ratio is calculated by dividing your monthly debt payments by your gross monthly income. The expenses that are used include your rent (or mortgage, property taxes, and insurance payments), auto loans or lease, revolving and installment credit, and payments resulting from legal liability, such as child support, alimony, and tax payments.
Subdivide your DTI ratio into two sub-categories for better tracking purposes:
- Front-end debt-to-income (DTI) ratio: This represents your monthly housing costs, which is either your rent or your mortgage costs (principal, interest, insurance, property tax) divided by your monthly gross income.
- Back-end DTI ratio: In addition to your front end expenses, including your monthly required payment for all other installment and revolving credit including credit cards, auto loans
- Savings-to-Income ratio: Divide your monthly savings- including retirement, investment, and regular savings plans- by your gross income.
- Monthly Cash Flow: Divide your monthly expenses by your gross income.
Here are some rules of thumb for each ratio:
- Front-end DTI: 31%
- DTI: 44%
- Savings: 10%
- Monthly cash flow: 100% (if more, then you are running a deficit)
Debt settlement and credit are not a good mix. When you stopped making payments, you broke the first rule of maintaining a good credit score- making timely payments. In order to rebuild your credit, focus on improving your credit score and if possible, repairing your credit report.
By going through the debt settlement plan and erasing your debts, you have immediately improved your debt-to-income ratio.
Rebuilding your credit by improving your credit score is possible, but takes time. Use these tips based on the five components of the FICO score:
- Timely payments: Make all your payments on time.
- Credit Utilization: When you get a credit card, pay it off each month in order to maintain good credit utilization.
- Length of credit history: Keep your cards active.
- New Credit and Credit Mix: Take out a secured credit card. If your wife has a credit card, then become an authorized user. Take out an auto loan or small installment loan. Make sure you can afford the payments. If your wife has good credit, then use her as a co-borrower.
Rebuilding credit through credit repair is possible but difficult. Your credit report includes positive and derogatory (or negative) trade lines. Derogatory accounts including late payments, foreclosures, public records, and collections remain on your credit report for 7 ½ years. (Chapter 7 bankruptcies remain for 10 years and tax liens don't have expiration dates). As these items age, their effect will lessen on your credit score.
Here are a few methods of improving your damaged credit report:
- Do It Yourself: If your settlements are not reported correctly send letters to the collection agency asking for a correction to their report. Instead of reporting the item as charge off, they can change it to settled charge off.
- Credit Repair agency: Speak to a credit repair agency to dispute items on your credit report. Remember, there is no guarantee that they can remove items that are correctly reported. However, sometimes an original creditor will not respond to dispute letters and the credit reporting agency will remove the item. (It could be reinstated). Read the Bills.com article Lexington Law review for more information about credit repair.
No matter which method you use, it will take time to repair your credit score and credit history. Monitor your credit report. You can get a free credit report every year from each of the credit reporting agencies (Equifax, TransUnion, and Experian) through annualcreditreport.com. Stagger your requests so that you get one every four months.
Buy a Home - Take a Mortgage
Rebuilding credit to buy a home is a good goal. Underwriting criteria differ from lender to lender and are continually changing. In general, a conventional loan will require 20% down payment, to get a loan without private mortgage insurance.
Your best option is to take a mortgage are an FHA loan, which has less stringent credit requirements. Here are a few FHA guidelines that will help you prepare for a loan:
- Down payment: 3.5%
- DTI ratio: 43% and a front end DTI of 31%
- FICO score: 580, although lenders may require higher.
If you cannot wait, then you can consider a loan on your spouse's name only. Your spouse will need to qualify for the loan based on their income and credit only. If you are considering an FHA loan, depending on if the state is a community law state, your debt and income may also be considered. Read the Bills.com article about applying for a mortgage when spouse has bad credit.
Rebuilding Credit and Buying a Home After Debt Settlement - It's Not a Dream
Deciding to go through debt settlement with Freedom Debt Relief was not an easy decision. Making it through the program took perseverance, proper budgeting, and the ability to make it deal with stressful situations.
Rebuilding credit takes time and patience. Remember to follow these points:
- Make your payments on time.
- Don't take loans or credit you can't afford.
- Save money for a rainy day fund.
- Save money for your down payment.
- Monitor your credit report.