Dear Debt Adviser,
Two years ago, I requested my credit report. It was not a good sight to see. Thankfully, I have cleaned it up to the best of my ability. I have paid off all my debt. I do, however, have one major problem. I settled an account with a debt collector. Now, instead of it stating "PAID," it says "derogatory." What is this? How can I remove it? Plus, now that I have paid everything off, I'm stuck with no credit. How do I start a smart credit history? I'm hoping to purchase a house within two years.
You already have started building a smart credit history. Your credit history, credit reports and credit scores are based on how well you have paid your debts in the past. Getting a copy of your credit report, paying your bills and setting a goal are great examples of personal financial "smartness." As you probably know, your less-than-smart record from a couple of years ago will stick around for seven years from the first date of delinquency. As for the "derogatory" notation, your account would have had a derogatory notation just from being delinquent, even if you hadn't settled it. The debt settlement just added insult to injury.
But, there is good news! You have done the most essential thing you could do to impress a lender. You have paid what you owe. Yes, you settled an account, but you took the time and trouble to hammer out an agreement that was satisfactory to you and to the debt collector. So, even though you show a settled account, that's preferable to an unpaid charge-off from a lender's point of view. Even lenders realize that everyone makes mistakes once in a while.
Now, on to how you can begin to build up your credit again so that you can reach your goal of buying a home. I'm not sure what your credit score is, so let's assume it's 550 to 600 using a FICO score or from 601 to 700 using the VantageScore. In that case, I would recommend that you begin with a passbook savings loan. This loan is secured by money that you deposit with the lender. You essentially borrow your own money at a very low interest rate. Your repayments will appear on your credit report as an installment loan. Check with the lender to be sure the loan will be reported to the credit bureaus. It should go without saying, but make all payments on time.
Other installment loans you might consider would be a purchase loan for furniture or other large item, or a car loan if you are in the market and can afford it. Try to stay away from finance company loans as a loan from that source will count less positively than say one from a bank or credit union. By all means, steer clear of using a payday loan in your rebuilding efforts. They usually don't report to credit bureaus and are not used in the FICO credit score when they do.
Next, I suggest that you apply for a secured credit card. These cards work the same way as the passbook loan in that you must deposit the amount of your credit limit with the bank issuing the secured credit card. Many banks will upgrade you to an unsecured card once you have made on-time payments for a specified period of time. Do some research and choose the secured card with the terms that are best for you. If you follow this plan and make all payments as agreed and on time, you will be well on your way to illustrating to potential mortgage lenders that you are a good credit risk.
One last insult to add to your credit injury. Any forgiven amount larger than $600 will be reported to the IRS and show up on a Form 1099 as income later this year. So, if you settled a $5,000 account for $3,000, you can expect to find a 1099 form for $2,000 in your mailbox. You will be required to include the amount from the 1099 form as taxable income on your next tax return.
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