Turning bad credit into creditworthy

Dear Debt Adviser,
I am a single, 47-year-old female in the process of repairing my credit. I have bankruptcy in my history, from about five or six years ago. I have a 403(b) for retirement planning, but no savings. I make about $90,000 a year, and I continue to pay rent and debt. I want to purchase a townhome now, but with bad credit, no savings and no one to borrow from, it appears that it is impossible, despite my good salary. Do you have any advice?
— Michele

Dear Michele,
Better late than never, I always say! One of the things I never liked about the old bankruptcy process was that it never taught anyone anything except that they could go bankrupt. The new law has a prefiling counseling component and requires predischarge education. If either of these requirements were in place when you filed for bankruptcy, my guess, backed by recent research, is that you would have some serious savings and be creditworthy by now, especially given your income.

So let’s get started positioning you for becoming a homeowner. You have already set your goals, and that’s the first step. Next, I suggest you develop a budget, or spending plan, to get control of your spending and allocate money to savings. Have regular deductions directly deposited into a savings account from your paycheck, and you’ll never miss it. OK, maybe you’ll miss it at first, but you’ll get used to it in no time. In the future, I suggest you allocate half of your raises and Internal Revenue Service refunds to savings as well. It’s truly painless.

Keep paying down your debt based on your budget, and that alone will help you repair your credit. Paying your bills on time makes up 35 percent of your FICO score.

Some other credit repair moves include not just making your payments to your creditors on time, but for the amount agreed. So no payments a day late or a dollar short!

As you know, you can’t erase any of the accurate negative information on your credit report such as your bankruptcy. But each time that new positive data is reported to your credit file, your negative history will count for less. In addition, you still can make sure that all items that are on your report are accurate and not out of date. Get a free copy of your credit report from Annualcreditreport.com. If you don’t recognize a negative entry in your file or it’s over 7 years old, dispute it with the bureau or the lender reporting the item.

Most negative data comes off your credit report in seven years. Still, your Chapter 7 bankruptcy will remain for 10 years. Also, if you have any unpaid, charged-off accounts, I recommend that you pay them. Paying them will not improve your credit score, but many mortgage lenders will not lend to you with unpaid, charged-off accounts on your report.

When determining how much house to buy, consider what you need first and what the bank says you can afford second. Or maybe third! Keep in mind that you are more likely to live happily ever after if you purchase a home with a mortgage that is well within your ability to pay. Most lenders are looking for mortgage-related payments of no more than 28 percent of gross income, and total debt payments (mortgage, car loan, credit cards, condominium fees, etc.) of no more than 36 percent of gross income.

Of course, this doesn’t include your need to build savings or eat regularly. Purchase a home where your percentages for mortgage and total debt are much lower than the maximum allowed, and you’ll be ahead of the game.

Lastly, save, save, save. The bigger your down payment, the bigger your cushion will be in case prices keep falling, and the lower your debt-to-income ratio will be. Start saving aggressively and begin researching mortgage lenders to help determine which lender will be a good fit for you. In the next year or two, you should be well on your way to realizing your dream of home ownership.

Good luck!

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