I have some friends that live nearby who were looking a year or so ago at buying the home they were renting. I had the privilege of sitting down with them for a couple of hours to review their finances and their credit in hopes of helping them understand what it takes to set up a strategy to get them to the point of qualifying for a home loan.
Yes, like many households, they had a few outstanding debts and a number of overdue accounts. Of our discussion that night, what floored me most was not their situation but their mortgage broker had suggested: open two credit card accounts, make several thousand dollars of purchases on each, carry a balance on them for six months making only the minimum payment, and then pay them off. I immediately thought about what Al Bingham, author of Road to 850, shares in his presentations about mortgage lenders. Al says that only 30% of mortgage lenders pass the credit section of their certification test!
My friends’ lender was likely passing along information that they had “heard” might help. We think that lenders should be pretty knowledgeable about these things since they work with credit all the time, right? Reality #1: Many of the mortgage lenders most of us do business with are essentially sales people. In some departments, turnover rates are high and experience levels low. Such companies often set sales goals (mortgages sold) for their lenders to meet. So how are we supposed to know if we can trust our lender? A face-to-face meeting, a handshake and some direct questions go a long way to revealing their experience and commitment to us as home buyers.
Back to my friends. If they could afford to pay the extra $500 just in interest that those new cards were going to charge them in the first 6 months alone, they probably could have afforded to get their delinquent accounts paid off and current. Additionally, the bad advice assumes that credit scores want us to carry a balance from month to month. Wrong! Reality #2: Paying off our balance every month has a very positive impact on our credit scores.
So here’s something to keep in mind when we’re trying to build or rebuild our credit: Make purchases on credit only if we were going to make the purchase with cash anyway, and then we should pay it off (either immediately or with the first account statement). As an example, if we’re going to buy new tires for our car anyway, we could apply for a line of credit from that tire store and then pay it off with the first statement they send us (or sooner). I just suggest that we don’t apply for more than 1 or 2 new credit accounts each year.
Heck, we could even purchase a hamburger on a credit card and then make the payment to the credit card company online that afternoon, and we’d still be building our credit score.
In summary, if it sounds like crazy advice (carry a balance for six month and incur extra interest to build credit), it likely is crazy advice. Instead, consider the following:
- Pay off any balance in full every month and do it on time. That doesn’t sound too crazy.
- Don’t apply for lots of new credit within a short period of time. Again, not too crazy.
- Avoid using the corner finance companies that offer “quick and easy” loans. Such accounts have a negative impact on our credit worthiness rating.
- Oh, and I recommend steering clear of companies that tell us they can repair our credit for a fee (usually $500 to thousands of dollars). These are short-term “fixes” that typically don’t address the real issue behind the lagging credit score.
Slow and steady wins the race and builds our credit score.