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.