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Rebuilding your credit for a VA home loan

January 5, 2015
Buying a home and financing it with your VA home loan benefit is an exciting time. Yet not so exciting when the borrowers find out their credit score is too low to qualify for a mortgage. In fact, it's very disappointing. VA loans are more forgiving as it relates to credit scores compared to other loan types but there are minimum standards that the VA requires and it is incumbent upon the VA lender to independently determine the veteran has demonstrated a responsible credit history.

The VA does not establish a credit score requirement, only that the lender must determine creditworthiness. Lenders use credit scores as an indicator of the likelihood of defaulting on the loan with scores ranging from 300 to as high as 850. The higher the score, the better the credit and while the VA doesn't have a score requirement, most VA lenders do set the minimum at 620 or 640, depending upon the lender.

How scores work

Credit scores are a reflection of past credit patterns, with emphasis on the most recent two year period. The older the credit, the less important it is. The calculation is a result of applying an algorithm developed by Fair, Isaac Corporation, commonly known as FICO. Businesses report the payment patterns of their customers to one or all three of the main credit bureaus, Equifax, TransUnion and Experian.

These bureaus use the FICO method to produce the three digit score and while the three scores are usually similar they are very rarely exactly alike. This variance is due to the reporting requirements and dates the information is delivered to the three bureaus. When a veteran applies for a VA loan and credit is pulled, the credit scores may read something to the effect of 741, 738 and 745. Which score does the lender use? VA lenders throw out the highest and lowest score and use the middle one for loan evaluation.

There are five categories that comprise a score and they are;

  • Payment History (35%)
  • Account Balances (30%)
  • Length of Credit (15%)
  • Types of Credit (10%)
  • Inquiries (10%)
Each category has its own impact on the total score, with Payment History and Account Balances accounting for two-thirds of the overall score. Length of credit is how long the applicant has used credit I the past, types of credit applies to loans from different types of creditors such as a mortgage lender or finance company and inquiries accounts for new credit applied for. Applying for new credit while applying for a mortgage at the same time is discouraged because it will hurt the score and the VA lender will want documentation of the inquiry, making certain no additional credit has been granted.

Fixing it

Okay, now say the borrower has a middle credit score of 550. What steps must be taken to improve the score? The first method is to make certain the negative information in the file is correct. If there is a blatant error that is hurting the score, the borrower can provide necessary documentation to the VA lender who can work directly with the credit bureau to correct the error and re-run the score. That's the easiest way, if there's a mistake.

If there's not a mistake, the borrower should concentrate on the two categories of payment history and account balances. The others are certainly important but by taking care of the first two, the rest should take care of themselves.

Payment history looks directly at any late payments in your credit report. When a payment is made more than 30 days past the due date, it is reported to the credit bureaus. The same report is made when payments are more than 60 or 90 days late as well as when loans are sent to collection or charged off.

The quickest way to repair credit is to stop making late payments as this single category accounts for more than one-third of your score.

Account balances compares the outstanding loan amounts with available credit. If a credit balance is $5,000 and the credit card limit is $10,000 then the borrower is using 50 percent of available credit. This much debt however will hurt a score as the ideal balance to limit percentage is around 30 percent. As long balances increase and approach, or even exceed allowable limits, the credit scores will continue to plunge. The goal here is to pay down existing balances until they reach 30 percent of available credit and charge no more.

Concentrate on these two categories for the next six to eight months and you'll see marked improvement. It's a process and it may seem like a long time but over the next year you will either have better credit or not. For those who want to improve their scores, this is the starting point.

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