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Chapter 5: Credit Preparation (full)

Before starting the process to purchase HUD homes, it is important to get your finances in order, which includes preparing your credit for the purchase of a home. Many people feel that they will never be able to purchase a home due to bad credit or no credit. However, purchasing government foreclosures is a nontraditional form of home buying that can offer those with no credit or less than perfect credit to finally realize their dream of home ownership.

The good news for potential buyers is that almost every credit issue can be taken care of in some way. In some cases, buyers may need to take a bit of time to deal with credit disputes or to raise their credit score. In some cases, potential buyers may be able to compose letters of explanation that explain negative marks on their credit report, which may result in a lender approving their mortgage. Those who have no credit history can even find excellent ways to establish a credit history so they too are able to qualify to purchase a HUD home.

In this chapter, buyers will find more information on some of the most common credit challenges and important strategies that enable them to prepare their credit for the buying process.

Credit Myths About Purchasing a Home

No matter a buyer’s financial situation, credit is important when purchasing any home, including HUD homes. Although many realize that credit is an important factor when making a purchase, many credit myths exist today that buyers must be aware of if they are planning the purchase of government foreclosures in the future. The following are several of the most common credit myths regarding a home purchase.

Myth #1 – There’s No Need for Those Who Pay Bills on Time to Worry About Credit

Many potential buyers think that there is no need to worry about their credit score and credit report if they always pay bills on time. For instance, they may have never defaulted on a credit card bill or loan, but this does not mean that buyers should not worry about their credit score and report. Many different factors actually affect the credit report and the credit score, which means that simply paying bills on time may not be enough to provide buyers with good credit. Credit bureaus take into account ration of available credit to credit used, length of credit history and the types of credit being used. Scoring low on a couple factors could lower an overall credit score, even if buyers are consistently paying bills on time.

Myth #2 – Checking Credit Scores is Enough

While buyers definitely should check their credit scores, they should never ignore their credit report if they plan to purchase a home in the near future. Lenders look at more than just the buyer’s credit score before making a decision – they also look at the buyer’s credit report. Buyers must know what is on their credit report to ensure any errors on the report are taken care of or addressed.

Myth #3 – Checking Credit Reports and Score is Difficult

Many buyers fail to look further into their credit history before considering government foreclosures because they feel it is too difficult. Today buyers will find it easier than ever to check both their credit score and their credit report. Sites like FreeCreditScore.com make it fast and easy to check credit scores and websites like AnnualCreditReport.com allow consumers to get a free copy of their credit report from each credit reporting agency every year.

Myth #4 – A Mortgage is Unattainable with Less Than Perfect Credit

While a good credit report and high credit score definitely helps when trying to get a home mortgage, less than perfect credit does not mean that a mortgage is unattainable. Many solutions are available for credit problems, allowing buyers to work on improving credit before purchasing HUD homes.

Common Credit Challenges Buyers Face

Buyers that want to consider the purchase of HUD homes may face various credit challenges. In some cases, buyers may have negative marks on their credit report or a low credit score due to financial hardship and extenuating circumstances. Events beyond the control of the buyer, such as death, divorce, unemployment and medical problems can result in credit challenges that leave buyers fearing they will never qualify to purchase a home. When considering the purchase of government foreclosures, buyers need to understand that FHA underwriters consider human circumstances. In this case, buyers may be able to secure the financing they need by providing lenders with a Letter of Explanation (explained further in the chapter) that explains the problems on the credit report.

Another common credit challenge that many buyers face is credit report errors. Often errors are present on the buyer’s credit report and those errors may negatively affect their credit. To deal with this challenge, buyers can address errors with the credit reporting agency to have errors removed from their credit report.

Last, some buyers have the challenge of no credit, which may be an obstacle to obtaining the financing needed to purchase HUD homes. While this may be a challenge, solutions are available to potential buyers that want to work on establishing their credit history. Often buyers are already making payments that may help them to show lenders that they are ready to handle the financial obligation that comes with taking out a mortgage on a home.

The Importance of Checking Credit Reports Before Buying

Credit reports are designed to measure a person’s credit worthiness and they are used to predict how likely a buyer is to repay debt in the future. Before deciding to purchase HUD homes, it is important that potential buyers take time to check their credit report.

Why should buyers check their credit report? In many cases, errors may occur on a credit report and any errors may not be corrected promptly. Even if a buyer has taken measures to improve their credit score and credit report, it may not be showing up on their credit report. For this reason, buyers need to take a closer look at their credit report so they can ensure their credit report is free of errors.

What can be done about errors on a credit report? Consumers have the ability to dispute any errors on their credit report, asking credit reporting agencies to eliminate entries that are in error. However, consumers must be able to prove that an error has been made.

Buyers need to remember that they have three different credit reports – one from each of the credit reporting agencies. These three agencies include Experian, Equifax and Trans Union. Consumers are legally entitled to a free copy of each credit report annually. These credit reports can be obtained by visiting AnnualCreditReport.com or by calling each credit reporting agency. The following is the contact information for each credit reporting agency:

  • Experian – (888) 397-3742
  • Equifax – (800) 997-2493
  • Trans Union – (800) 888-4213

Using a Letter of Explanation to Explain Credit Problems

If a buyer has derogatory entries on their credit report, one of the best solutions for dealing with this problem is to write a letter of explanation to potential lenders. The letter of explanation may include explanations for soft credit inquiries and each derogatory entry that shows up on the credit report. When writing a letter of explanation, several components need to be included for every entry made.

  1. Start by citing the inquiry or entry, using the name of the creditor, the date and the amount involved.

  2. Offer an explanation of the problem. This is the time for honesty, even if it includes personal challenges. Buyers should include information about events that may have made meeting the obligation beyond their control, such as an illness, job loss or other personal problem. If a mistake was made, buyers should admit making a mistake and then go on to show what they have learned.

  3. For buyers that have worked to correct the credit problem, the steps taken should be described and providing documentation of these claims can substantiate the claim.

  4. This letter should be concluded with a paragraph that describes how the buyer has improved their financial habits. It should also inform the lender that the buyer intends to perform on the loan in a credit worthy manner.

  5. At the end of the letter, any documentation that may be used to prove financial situations or measures taken to fix credit problems should be included. For instance, divorce paperwork can be used to substantiate claims that a divorce has negatively affected credit. Buyers may use unemployment records or even a layoff notice to backup claims of job loss. The more documentation buyers can provide the more effective the letter of explanation will be.

No Credit – How to Establish Credit Before Purchasing HUD Homes

While some potential buyers have a problem with their credit report, another common problem for potential buyers is no credit at all. The good news is that buyers can work on establishing credit before purchasing HUD homes. Many measures may be taken by buyers to establish credit. For instance, simply borrowing some money and paying it back in a timely manner can help to establish some credit

Another excellent way that credit may be established by potential homeowners is by using Pay Rent, Build Credit, Inc. (PRBC). This service helps consumers to use recurring bill payments and rent payments to help build a positive credit history. Consumers can build a historical credit file by using various multiple payment accounts, including phone bill payments, insurance payments, rent payments, utility payments, student loan payments and more.

By making use of credit card, online, ACH, phone, and debit payments, electronic recipes that are date stamped can be sent to PRBC to help build credit files that are independently verified. Without having to take on any new debt, those without a credit history can easily show that they are ready and able to handle larger financial obligations, such as a home mortgage on HUD homes. This offers just one excellent way that potential buyers of government foreclosures can establish and show credit worthiness to potential lenders.

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