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First Time Home Buyers Guide

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Knowing and Understanding Your Credit

There are steps you can take to get closer to your dream of home ownership.

One step is to establish good credit, especially if you have had credit problems in the past. Establishing good credit might mean taking care of your debts or getting in the habit of paying your bills on time. Or it might mean creating a nontraditional credit history if you have never borrowed before.

Another step is to keep your good credit once you have it.

These steps can take time and determination, but they can be done.

What is credit? If you have ever taken out a loan to buy something a car, for example you were given credit. Credit means you are using someone else’s money to pay for things. It also means you are making a promise to repay the money (the loan) to the person or company that loaned you the money (the creditor or lender).

A loan usually includes both principal (the amount of money you borrowed) and interest (the additional dollars you pay for the privilege of borrowing the money). Because a loan is a legal obligation, it is important to understand how you must repay it. Good credit means that you make your loan payments on time and you repay your debts as promised.

Good credit is important because it makes it more likely that you can get a new loan in the future when you want to make a major purchase, such as a car or a home. When you have a good credit record, lenders feel more confident that you will be willing and able to pay back the new loan.

It’s true that you need good credit to buy a home, but you don’t need perfect credit. If you don’t have good credit right now, don’t get discouraged. You can use the ideas here to start improving your credit. It may take some time, but you will be far better off if you improve your credit before you apply for a home mortgage loan or other large purchase. This is important because if you have a habit of not paying your bills on time, or have a lot of debt, you may not qualify for a mortgage loan. Or the lender may give you a loan, but with a larger down payment requirement or at a higher rate of interest.

If you pay a higher rate, you could end up paying thousands of dollars more in interest for your home. For example, an $80,000, 30-year fixed-rate mortgage at 7 % interest will have a monthly payment of approximately $532. Compare this with a monthly payment of $644for the same $80,000 mortgage at 9 % interest. Over the life of the loan, you will pay close to $40,000 more for the 9 % than you would for the 7 % loan.

As you can see, it may be wise to take care of any credit problems you have before you start looking for a home so you can apply for the best interest rate possible.

How do I know if I have good credit?

Sometimes people think they have good credit.

Then they apply for a loan and are surprised to learn that there are some problems with their credit. The best way to find out if you have good credit is to get a copy of your credit report.

What is a credit report?

A credit report is a record of how you have paid your credit card debt and other loans. A credit report shows how much debt you have, if you have made payments on time, or if you have not paid back some loans at all.

Credit reports do not show information about your race, religion, medical history, personal lifestyle, political preferences, criminal record or any other information unrelated to credit.

Credit reports are compiled by national credit-reporting agencies. The typical credit report includes four types of information:

  • Identifying information: your name, current and previous addresses, telephone number, Social Security number, date of birth, and current and previous employers. This information comes from your credit applications.


  • Credit information: specific details about your credit cards, student loans, and other loans. This information includes the date opened, credit limit or loan amount, balance, and monthly payment. The report also shows your payment history during the past several years, and the names of anyone else responsible for paying the account, such as a spouse or a co-signer. Late payments, skipped payments, accounts turned over to a collection agency, and repossessions appear here. This information comes from companies you do business with.


  • Public record information: bankruptcy records, foreclosures, tax liens for unpaid taxes, monetary court judgments (such as lawsuits), and, in some states, overdue child support. This information comes from public records. See an example below.


  • Inquiries: the names of those who obtained a copy of your credit report and how often you have applied for credit in the past two years. When you order a credit report, you may also see the names of companies that have reviewed your report for “pre-approved” credit offers. However, these names will not be given to creditors who request a copy of your report.


  • Creditors only see the inquiries you initiate (by applying for a new credit card, for example). Creditors rely on this information about how you’ve handled your loans in the past to decide how likely you are to repay a new loan.

    When you apply for credit or a loan, you give the creditor permission to order your credit report from a credit-reporting agency.


    How to Order a Credit Report

    The best way to know what your credit report shows is to order one and review it carefully. It’s a good idea to order your credit report once a year to make sure there are no errors on it. You can order your credit report from any of the major credit reporting agencies listed below.

    When you order your report, have ready your Social Security number, date of birth, current and previous addresses for the past five years, and maiden name, if applicable. You may have to pay a small fee (about $8) to get your credit report.

    Experian1-888-EXPERIAN (397-3742)
    Experian.com
    Equifax1-800-685-1111 Equifax.com
    Trans Union Corporation 1-800-916-8800 TransUnion.com

    Credit reports are also free after you have been turned down for credit. However, you must ask the agency that produced the credit report for a copy of it within a specified period of time, usually 60 days.

    The information on your credit report may vary from one credit reporting agency to another. This is because not all creditors report their information to every credit-reporting agency. For this reason, you may want to order a report from each of the three credit-reporting agencies.


    How to Understand Your Credit Report

    Several types of organizations are available to help you understand your credit report at little or no charge. For example, you can ask for help from the credit-reporting agency that sent you the report, or you can visit a nonprofit credit-counseling organization. You can also get help from lending institutions, credit unions, or local housing assistance agencies in your city or county.

    How to Correct Errors

    Credit reports should be accurate, but it is important to make sure. If there are errors or outdated information on your credit report, it could hurt your chances of getting a new loan. The good news is that you have the right to have the mistakes corrected at no charge to you. Here’s how:

  • The credit report may include information on how to correct errors. Follow the instructions that you get with the credit report to tell the credit-reporting agency about the mistake.


  • A phone call to the agency alerting it of the error often will take care of the problem.


  • If additional information is needed to correct the error, the credit-reporting agency will tell you what to send. For example, the agency may ask for copies of canceled checks or other payment information. If you have kept good records of this information, it will be much easier to show where a mistake occurred.


  • you may also wish to explain the problem in a brief letter. The credit-reporting agency must investigate your complaint within 30 days and get back to you with its results. As part of its investigation, the agency will check with the creditor whose information you are questioning.


  • If the agency finds that the information in the credit report is inaccurate, the creditor must notify the other major credit-reporting agencies of the error so they can correct their information. If the credit-reporting agency does not find an error, but you still believe your credit report is inaccurate, you can contact the creditor directly to try to straighten out the problem.

    When you resolve the dispute, ask the creditor to send a correction to the credit-reporting agency. You also have the right to explain your side of the story on the credit report if the issue remains unresolved. You may write up to100 words to explain the situation. The statement will appear on your credit report. For example, if you did not pay a car repair bill because the mechanic did not fix the problem, the unpaid bill may show up on your credit report but so will your explanation.

    Credit Reports and Credit Scores

    You may wonder how a creditor can look at all the information on your credit report and make a fair decision about your credit. One way creditors do this is by using a computer model to analyze your credit report and give it a credit score.

    What is a credit score?

    A credit score is used to predict how likely an individual is to repay a new loan based on experience with millions of consumers. There are many different computer models that can calculate a credit score. In general, however, the computer model assigns points to information in a credit report. For example, making payments on time every month is positive for the score. Charging the maximum amount available on a credit card is negative. The computer adds the positive and negative points, and the resulting number is a credit score.

    What is a “good” credit score?

    That depends on the credit scoring model and the lender. For example, one computer model ranges scores from 300 to 900; the higher the number, the better. In addition, each creditor decides what credit score range it considers to be a good risk or a poor risk. For this reason, the creditor is the best source to explain what your credit score means in relation to the final credit decision.

    Why are credit scores used?

    Creditors, including mortgage lenders, use credit scoring because it is a fast, objective way to evaluate a credit report. Credit scoring also protects you. This is because your age, health, race, religion, gender, national origin, marital status, income, and employment are not considered in determining your credit score.

    How can I improve my credit score?

    If a creditor has told you that you have a poor credit score and has turned you down for credit because of your score, there are steps you can take:

  • First, you have the right to request a written explanation from the lender that turned you down. The letter must explain the reasons for the credit denial. Then you can make a plan to begin to address these issues. As you improve your credit over time, your credit score will also improve. Also, remember that the lender, not a credit score, makes the final decision to approve a mortgage loan application. A credit score is simply a tool used by the lender. The lender may take into consideration any special reasons for your past credit problems. In addition, the lender will look at more than just your credit score—such as your equity investment in the home, job history, income, savings, and the type of mortgage loan you want before making a final decision.


  • How will late payments affect my credit?

    Paying bills on time every month is one of the best ways to build good credit. Of course, sometimes people forget to pay a bill. Or an unexpected event like a serious illness distracts them from paying bills by their due date. If this has happened to you only once or twice, the late payment may show up on your credit report, but you can explain to a creditor why it happened. When people often pay bills late, however, it can hurt their credit. Creditors’ experience has shown that people who do not pay their bills on time are more likely to have difficulty repaying a loan than people who pay on time.

    Here are some ideas for avoiding late payments:

  • Mark on a calendar when you must mail your bills each month so they will arrive before the due date.


  • Pay bills automatically out of your checking account every month. Gas, electric, telephone, and insurance companies often encourage their customers to pay their bills this way. If you use automatic payments, be sure you keep track of them in your checkbook


  • If you take a trip out of town, make a plan for keeping your bills up to date. For example, you might ask a friend to pickup your mail and send you your bills so you can pay them while you are gone. You can also call your creditors before you leave town and arrange to pay your bills ahead of time. Taking these steps will improve your credit over time. In general, creditors look for a two-year history of paying bills consistently on time to help establish good credit.133What else will help me take control of my credit? In addition to paying your bills on time every month, you can take other steps to improve your credit or maintain the good credit you already have.


  • Steps you can take on your own.

  • Pay loans first. Pay them before you spend money for things like going out for dinner or to the movies. Missed payments hurt your credit rating.


  • Pay off credit cards every month. If this is difficult to do, cut up the card so you can’t use it. Or put the card away until you pay it off. Then only use the card if you have an emergency or know you can pay the balance every month. Otherwise, write checks or pay cash for items you buy.


  • Remind yourself that credit cards are loans. Before you pull out your credit card, ask yourself, “Would I really take out a loan to buy this?”


  • Charge less than the maximum amount available on your credit card. Even if you make the payments on time, creditors may think that you are in too much debt.


  • Only apply for the credit you need. Every time you apply for credit, it appears on your credit report. If you apply often, creditors may be concerned that you are using too much credit. Even if you do not open the charge account, your application may raise a flag that you may be having cash-flow problems. Avoid applying for credit cards just for fun, or to get a “free” gift or a discount on a purchase.

    If you feel you can wisely use a credit card, choose one with a low interest rate and no (or very low) annual fees. Credit cards issued by department stores or other stores usually charge higher interest rates than bank credit cards. You can use the Internet to shop for a card with low fees and low interest rates. Compare the fees and rates of any offers you receive in the mail. Do not pay an up front fee to get a lower rate on a credit card. An up front fee is different from an annual fee and is often a scam.


  • Try to pay more than the minimum due each month. When you only pay the minimum, you end up paying a lot of money in interest charges. For example, assume you use a credit card with an 18 percent interest rate to buy a sofa for$1,000. You only make the minimum payment of 2 percent each month (about $20). At that rate, it will take you about 90 months (or 7 1/2 years!) to pay off the couch, and it will end up costing you about $1,800 when you include interest charges.


  • Use your credit card to establish good credit. Although you can get into debt trouble if you overuse credit15cards, you can also use credit cards wisely to show that you can manage credit well. Just be sure to pay the credit cards off every month or keep the balances very low.


  • Look for ways to cut your expenses or increase your income. This will give you more money to pay bills. For some ideas, see the section of this guide on budgeting.


  • Keep track of bills and past-due notices. Do not think that a debt has disappeared just because you may have stopped receiving notices. For example, doctors or hospitals sometimes stop sending bills to patients after several months. But if they turn the bill over to a collection agency, it will show up on your credit report. Unpaid student loans will also appear on your credit report and may prevent you from getting a loan. Check your credit report to see if you have any of these debts. Then take steps to start paying them before you apply for a new loan.


  • Getting Help

  • If you are having problems paying your debts, call your creditors to discuss your options.


  • Call them before you miss a payment. This may be a difficult step, but it is less embarrassing than receiving phone calls from creditors demanding payment. If you bought a car and are having trouble making the payments, for example, it may be better to sell the car and pay off the loan than to let the credit or repossess the car. A repossession will hurt your credit rating.

  • If you owe money to many businesses


  • It may be time for expert help. Consider going to a nonprofit credit-counseling organization. These organizations can work with you and your creditors to setup a repayment plan. They will provide this service at little or no cost. Your lender or creditor may be able to refer you to a credit counselor. Other places to look for a credit counseling service include universities, military bases, credit unions, banks, and housing authorities.


  • Stay away from “credit-repair” companies


  • Legitimate, nonprofit, community-based counseling organizations provide a much-needed service to people who are having credit problems. Don’t confuse these organizations with so called credit-repair companies that offer to fix your credit history for a fee. It can’t be done.

    Only you can repair your bad credit by repaying your debts and paying your current bills on time.

    Promises like “We can erase your bad credit,100 percent guaranteed” are not true. To check out a company’s reputation, call the Better Business Bureau or your state’s Attorney General.

    A note about bankruptcy, foreclosures, and repossessions. If you have not paid a loan and have had a car repossessed, a house foreclosed on, or have declared bankruptcy, it will have a major effect on your ability to get new credit.

    Information about a foreclosure or repossession can stay on your credit report for seven years.

    A bankruptcy can stay on your credit report up to 10 years.

    If you are in one of these situations and want to apply for a new loan, there are several things you can do. First, you might write a letter to the new lender explaining why the problem occurred. For example, perhaps you were seriously ill, recently divorced, or lost your job. Another suggestion is to wait a few years before you apply for a new loan. The length of time you must wait will depend on the lender’s rules and the size of the loan for which you are applying.

    During that time, make a strong effort to reduce your debt and pay your bills on time. When you apply for a loan again, make sure the lender knows the steps you have taken to improve your credit.


    How Can I Create a Credit History If I Don’t Have One Now?

    You may prefer to pay cash for everything you buy. You may never have taken out a loan. Or perhaps you are recently divorced and do not have any credit in your name. If you are not in debt, you should feel good about that.

    However, if you have never made a loan payment or used a credit card, you may not have any credit history. This can be a problem when you get ready to buy a home and apply for a mortgage loan. The mortgage lender will want to see a record of how well you can pay bills and manage credit. If you don’t have credit cards or loans, you can still put together a credit history.

    You can create your own report to show a lender that you pay your rent, telephone, car insurance, medical, and utility bills on time each month. This is called a nontraditional credit history.

    Here are suggestions for building a nontraditional credit history:

  • Keep copies of bills you pay, including your rent, telephone, electricity, cable television, gas, and insurance.


  • Keep copies of the canceled checks used to pay your bills.


  • Ask your landlord, the telephone company, and the gas and195electric company to write you a letter. Ask them to include how long you have been a customer and how well you have paid your bills every month.


  • Show your bills, payments, and letters to lenders to prove that you pay your bills on time every month. A record that shows at least two years of regular payments is ideal.


  • Although overuse of credit cards can get people into debt trouble, using one or two credit cards wisely is a good way to establish a credit history.


  • Consider asking your bank if it can issue you a “secured” credit card, backed by your savings account, to help you establish credit. Be sure you understand any fees involved and the terms for making payments.
    Then use the card for some of your purchases. Make the credit card payments on time every month to show you can handle credit well. You can also apply for a credit card on your own, directly from a credit card company.


  • If you are married, make sure some credit accounts are in your own name as well as your spouse’s name, so you will both build a credit history. Also remember that you are responsible for paying any loans or credit-card debts that are in both names.


  • Ask a nonprofit credit-counseling service or housing assistance agency for help in preparing a nontraditional credit history.



  • How Can a Budget Help Improve My Credit?

    One excellent way to take control of credit is to use a budget. Think of a budget as your spending plan. It helps you plan where you will spend your money and how you will save some of it. Another good reason for having a budget is that it helps you get ready to buy a home. When you apply for a mortgage loan, the lender will ask you how much income you have and what your expenses are. A budget will show that information.


    There are four steps to making a budget

  • List your income.


  • List your expenses.


  • Compare income and expenses.


  • Set priorities and make changes so that your income will be greater than your expenses.


  • For a budget to work, it must be accurate. For example, don’t overestimate your income. Also, don’t forget bills that only come due every few months or so, such as car insurance. In these cases, list the average cost per month. For example, if you pay $450 for car insurance every six months, you must save $75 each month to pay the bill ($450 ÷ 6 = $75). If you are not sure how much you spend on things, write down everything you buy for a few months. This will help you see where you spend money and where you might be able to cut back so you will have more money for savings or to pay other bills.

    EXPENSES

    Housing Expenses

    Rent/mortgage $____________

    Property tax/insurance $____________

    Home maintenance $____________

    Electricity $____________

    Gas/Oil $____________

    Water $____________

    Other $____________

    Non-housing Expenses

    Food $____________

    Clothing $____________

    Day care/tuition $____________

    Car loan(s) $____________

    Car insurance/tax $____________

    Gas and oil $____________

    Car repairs $____________

    Health care not covered by insurance $____________

    Credit card #1 payment $____________

    Credit card #2 payment $____________

    Credit card #3 payment $____________

    Other loan payments $____________

    Alimony/child support $____________

    Entertainment $____________

    Telephone $____________

    Cable $____________

    Insurance (other than car) $____________

    Savings for emergency fund $____________

    Other $____________

    TOTAL MONTHLY EXPENSES $____________

    INCOME Net (take-home) pay $____________

    Net (take-home) pay $____________

    Net overtime $____________

    Pension, Social Security benefits $____________

    Investment earnings $____________

    Public assistance $____________

    Alimony/child support $____________

    Other income $____________

    TOTAL NET MONTHLY INCOME $____________

    TOTAL MONTHLY EXPENSES $____________

    INCOME AFTER EXPENSES
    (Total Net Monthly Income Minus Total Expenses)

    $____________


    Cutting Expenses and Increasing Income

    Here are a few ideas for cutting expenses:

  • Buy only things you really need, not things you want.


  • Make a shopping list before you go to the grocery store and stick to it.


  • Pay with cash, not a credit card.


  • Use coupons.


  • Eat at home. Take your lunch to work.


  • Look for sales and off-season bargains. Compare prices.


  • Share driving or use public transportation.


  • Buy a used car instead of a new car with high monthly payments.


  • Shop at thrift stores, garage sales, or flea markets.


  • Consider discontinuing services you don’t really need, like cable TV, a cell phone, or a pager.


  • Avoid check-cashing stores, pawnshop loans, and rent-to-own stores. They can cost you a lot of money in fees and high interest charges.


  • Some ideas for increasing income are:

  • Get a part-time job.


  • Work overtime hours at your current job.


  • Sell items that you make or no longer need at flea markets and garage sales.



  • Why Are Checking and Savings Accounts Important?

    Checking accounts are important. If you pay your bills with cash, it is difficult to provide creditors with a record of how you manage your money.

    Having a checking account can help solve this problem. When you have a checking account at a bank or credit union, you can use your monthly statement and canceled checks to show creditors that you do a good job of paying your bills. In addition, it usually costs less to have a checking account than it costs to buy money orders to pay bills or to use a check-cashing store to cash your pay check.

    If you do not have a checking account, consider setting one up soon. Call several banks or your credit union. Ask what they charge and what services they provide. Choose the bank or credit union that offers the best deal and is the most convenient for you.

    Savings accounts are important, too. One of the best ways to improve your overall financial picture is to save money every month, even if it is only a small amount.

    Here Are Some Ideas to Start Saving Money

  • When you get your paycheck, pay yourself first by taking a certain amount of money ($10, $25,$50) out of your paycheck and putting it into a savings account before you pay other bills. Better yet, have your company take the money out of each paycheck automatically and put it into your savings account.


  • When you pay off a bill, continue making the same “payment” but put it in your savings account.


  • Another easy way to save: Put $1 a day in a jar. Then add your loose change to the jar. At the end of the month, you will have about $50. Once a month, take the money to the bank and deposit it into your savings account. By the end of the year, you will have $600 or more!



  • Options for Investing Your Money

    Banks and credit unions

    You can put your savings in an account at a bank or credit union. Banks and credit unions pay you extra money, called interest, for the use of the money you save at their institution. The great advantage of saving money is that it grows over time as the money earns interest. The longer you save, the more your money will grow. In addition, the federal government insures savings accounts, making them a safe investment. Shop around for the best interest rate, and ask if you must keep a minimum balance in the account to avoid service charges.

    Mutual funds

    When you invest in a mutual fund, the mutual fund company uses your money to buy shares of stocks and bonds of many different companies. In the United States, an investment in stocks has made more money over time than saving at a bank. However, investing in stocks is also more risky. If the stock market goes down temporarily, the value of the mutual fund may also go down. Unlike savings accounts at a bank, mutual funds are not insured by the federal government.


    Individual Development Accounts (IDAs)

    What would you do if you learned that for every dollar you saved, someone would add more money to your savings account? You would probably jump at the idea!

    There is such a program. It is called an Individual Development Account (IDA). You can use the money you save in an IDA to buy a home, pay school tuition, or start a small business. As part of the program, you also receive help in managing your money and building other financial skills. IDA’s are funded by sponsors.

    Some IDA sponsors are private, nonprofit organizations. Others receive government money. When you participate in an IDA, the money you save is matched by the IDA sponsor. For every dollar you save, the sponsor will usually add at least $1—or as much as $4 or more—to your IDA savings. IDAs are usually available to low-income people, but they are not available everywhere. To find out about IDA’s in your area, visit the Web site of Corporation for Enterprise Development at www.idanetwork.org. You can also check with your bank or credit union, church or religious organization, local housing authority, county welfare office, or community development group.


    What’s next? Knowledge is power. You now know many things you can do to maintain and improve your credit. Some of the steps you read about here will be easy and quick to accomplish. Other steps may take a few months, or even a few years. But every step you take will get you closer to your dream of owning a home.


    Let’s Quickly Review Those Steps

  • Order your credit report to find out if you have good creditor if you need to take steps to improve it.


  • Correct any errors you may find on your credit report.


  • Make loan payments on time every month.


  • Take control of your credit by reducing your debt, using credit cards wisely, and only applying for the credit you really need. Call your creditors or contact a nonprofit credit counseling organization if you need assistance.


  • Create a nontraditional credit history if you do not have any loans or credit cards.


  • Use a budget, a checking account, and a savings account to manage your money. Achieving the dream of home ownership may not be easy, but it can be very rewarding.




  • Source: The Fannie Mae Foundation.
     

    Choosing the Right Mortgage
    First Time Home Buyer Connecticut Guide
    Opening the Door to a Home of Your Own
    Steps for First Time Homebuyers in Connecticut
    What You Don't Know Can Hurt You

     



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