Don't Pay Off Bad Credit

Step three in the “Should I Buy a House Now” series is somewhat of a sidetrack.  In Step 1 people learned the difference in calculating your current gross income, especially if any part of your income is not guaranteed “salary”.  In Step 2 you were sent off on a long project of accounting for your past practices of spending that gross income.  By finding the money you wasted, and taking steps to waste less of your earnings, you were able to find additional monies to put towards housing payments.

Step 3) Start Improving Your Credit Rating This can take a long time, as does Step 2.  I am suggesting you do these simultaneously.  Don’t think that because you pay your bills on time, that you have good credit.  Paying your bills on time only accounts for 30% to 35% of your credit standing.

Get all copies of your credit history.  Generally there are three sources (or more) and you don’t want to get your credit score, you want full copies of your credit report.  Go through the reports and make sure the history pertains to you.  The more comon your name, the more likely you will have something of someone else’s on your report.  If you are divorced, you want to remove things that you are no longer legally responsible for by divorce decree, even if the item has a high rating.

Let’s assume you have at least one item that you didn’t pay well.  Don’t pay it off!  This is the biggest mistake I see people making.  You need to turn bad credit into good credit.  Paying it off does not remove it from your credit history, so paying it off simply locks in a bad credit item.  You want to “pay it as agreed”.  Sometimes you do that by agreeing to a new payment schedule and then paying the new payments on time for a year.  Sometimes you pay off the balance, but leave the card open, and charge one small item every month and pay that item off every month.  I’m not a credit expert for sure, but this issue goes back long before scoring was used.  All too often people pay off the balance on a bad credit item thinking they made it good.  No.  You locked in the bad long term.

Here’s a story from back when I was 25ish.  My Mom needed me to co-sign on a house.  I had a bad charge card at a department store that was charging me 3% of the balance due until it reached near the max, and then wanted 20% of the now higher balance each month.  There was no way on my income that I could pay 20% of the balance, so it got behind.  It was a ding that was potentially going to cause my Mom to not get the house and everyone panicked. 

I went to the store with the full balance due in my hand, and after a lengthy conversation with the credit manager, I was very angry and said I hated the store and would never buy anything there again.  The Manager said to me, “You can’t hate us.  In fact you have to buy from us.  You can’t just pay off the balance to restore your credit.  If you never buy from us again, that bad rating will sit on your report for years.  The only way for you to improve your credit is to buy more from us and pay off that more well.”  That made me angrier and I started to leave when a lightbulb went on.  I turned around and said, “Are you telling me that I can go downstairs right now and buy something on this card?  He said absolutely, please do.  I said can you give me a letter to that effect.  He said sure.  I took that letter to the mortgage company and said how can you deny my Mom a mortgage based on a bad credit item, when the bad credit item doesn’t think it’s so bad, in fact they invite me to continue shopping there on credit.  I handed them the letter from the Credit Manager on the store letterhead, they agreed and my Mom got the house.

Lesson learned:  Turning Bad credit into Good credit involves not simply paying off balances, but continuing to charge and pay as agreed until the credit rating for that item improves.  Then you can close it after it has a good rating.

I have to meet someone at a house shortly, so I’m going to end here though this post could be a 20 page short story, if I highlighted all the ways to good credit.  The point is EARLY in the process, here at Step 3, know your credit score, review your credit history from 3 credit bureaus, and improve as needed.  Even if your score is high, go through the detail and make sure you correct anything that needs correcting.  It takes a long time for the credit bureaus to reflect change…so don’t wait until the last minute to work on this step in the series.

32 thoughts on “Don't Pay Off Bad Credit

  1. When I meet with someone who wants to improve their credit, the first step is to determine if it’s for the purpose of getting ready to buy or refinance a home or is it because they want a higher a score. There are different strategies for both and (instead of writing a super long comment here) I may have to address it in a separate post.

    An excellent point in your post, Ardell, is that consumers often do what they feel is “the right thing” with their credit and it’s the wrong move providing the opposite result of what they’re after (lower scores) such as closing an established account.

  2. Ardell wrote: “If you are divorced, you want to remove things that you are no longer legally responsible for by divorce decree, even if the item has a high rating.”

    Good luck with that. The divorce decree doesn’t affect your liability to the creditor. It only determines who between the two spouses should pay. If that spouse fails, the creditor has every right to go after both. Based on that, I really don’t think you’re going to get such items removed from your credit report.

    BTW, this (divorce) is another area where you really need an attorney. I had clients in the past get into financial trouble because they went cheap on the divorce and basic precautions to protect one spouse from the other were not taken.

  3. Kary, very true. When I meet with people who say “but I have a divorce decree stating he/she gets the house and I’m not responsible for the mortgage”…they’re shocked to learn it doesn’t matter in the lienholders eyes.

  4. The reason it works that way is the lienholder isn’t part of the divorce action. Nothing in that action affects them.

    And the reason they’re concerned is divorce is one of the leading causes of bankruptcy. First, people in financial trouble tend to be more likely to have marital issues. Second, when the couple splits, their collective income remains the same, but their collective expenses go up. Thus divorce is likely to make a bad financial situation worse.

  5. Ardell:

    I think this is an area where experienced loan originators can, and do, make a difference.

    I’d recommend that anyone considering buying a home contact a loan originator early, so that you can plot out a strategy to get the best possible terms.

  6. I agree Roger, but I’m trying to do this series in a way that people who might be even three years or more from time of purchase, can use it. High School Students, College Students, parents who want to impress on their children some of the steps for establishing a good fincancial thinking foundation.

    I’m also trying to give people the means to not rely on the opinion of others entirely, as that is what started this mess.

  7. Pingback: From Rain City Guide: Should I Buy A House Now?

  8. i have a cable bill that i o them $500. i want to know what will be the right way to pay it off to make my credit good?
    please help me

  9. nene. If you no longer use that company for cable, there is no way to reverse the bad. It is not the kind of bill that you generally can convert to good if it is an old bad debt. Best to just pay that one off and get it behind you.

    If you neglect to pay someone…there is not always a way to make a “bad” a “good”. Generally having few bad and more good, and more recent good, is the best way to go. Unpaid amounts are often the worst, so your only recourse may be just to pay it off as soon as possible.

    If you don’t feel you owe it…then you should dispute it.

  10. Hi, feel free to email if answer is lengthy 🙂
    Basically, I have been going through the 3 credit reports of my husbands (married 2 years) and there is a LOT on there. I am a bit overwhelmed… there are of course some differences in what is reported on each one but we are talking upwards of 20 Bad Reports in the amount of $11,000 total.

    My question, is when they reach their 7 yr mark do the leave forever? If I pay the ones that still are there till 2014 will they show “paid in full” and bring the score up, or will it even affect it at all?

    Should I pay the ones that are at the 7 yr mark in 2010 or just leave them alone?

    Most of these are Loans, Cell Phones etc…


  11. Velma,

    I had a similar problem many years ago and opted to buy a house before I got married to avoid the issue. But we sold that house and bought a bigger one within a couple of years, so I only delayed the process.

    The way I handled it may not work today, given we didn’t have credit scoring back then, unless you are planning to buy FHA with a live underwriter. I gave the full amount to an attorney friend to hold while I worked on which ones to pay and not pay. By having paid it to a third party, the mortgage underwriter considered it to be paid and approved the mortgage. I do recall the 7 year not being “automatic” and my having to get the credit reporting companies to manually remove those.

    I used an attorney, and with the number of items you have on your plate, I’d suggest you consult a lawyer or credit counselor at the point when most of them are 7 years old or older. If you have a year or so before that happens, their ability to assist you may be increased if you wait to see if they automatically drop off.

    Good luck.

  12. Velma:

    Most loan originators know credit counseling companies to recommend. Whenever a client has that many derogatories that they want removed, I will usually suggest they use a service.

    Typical costs are around $100 set up, and a monthly fee of about $40 (until you decide to stop). You only get clerical help, but often that’s what is needed. They don’t do anything you cannot do yourself, but they can probably do it more efficiently.

    I do not recommend paying a large sum upfront for “guaranteed” results. No one can guarantee the outcome of credit cleanup.

    I have often worked with clients for a year or more, as they work their way through these kinds of issues, before they were ready to buy.

    As always, consult a local mortgage professional, or in this case, a mortgage and a credit professional.

  13. Ardell:

    I do not think of the “7 year rule” as a guaranteed outcome, or a reliable rule.

    One of the problems with credit reporting and scoring is that there are no hard and fast written rules that we can all play by. A lot of it is done according to hazy formulas.

    Most people don’t really need to think much about their credit…just pay your bills on time, and keep your CC balances low, and it will all work out fine.

    However, in my experience, those that have had a serious train wreck with their credit need to manage it carefuly over several years, as issues that have been beaten down can reappear. Some folks are great at managing the minutia of it, and some are not.

    These days, unless you are going FHA, it is well worth the effort to keep your score above 740.

  14. Velma,

    I agree with Roger, and warn that I have seen credit counseling help for a short time but not the long term. Managing it yourself for as long as you can is likely the best course, unless you have a target date it needs to be better by.


    Everyone being 740 or better is not realistic. I wonder what the guideline is for renting these days?

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