• Is It Possible to Clear Up a Bad Credit History?

    Brandon Cornett

    By Brandon Cornett
    © 2011 All rights reserved

    Reader Question: "I want to purchase a home sometime during the next year, but I have some stuff on my credit report that's hurting my FICO score. I have heard that mortgage lenders are being really strict right now. So I'm guessing I need to clear up my bad credit history before moving forward. Is this correct? And if so, where should I start with when clearing up my credit?"

    Let me start with your first question, regarding mortgage lenders. Yes, it's true that lenders have become stricter over the last few years. It all started when the housing market tanked, back in 2008. Ever since then, they've been looking for ways to reduce their risks. One of the ways they do this is by requiring higher credit scores from borrowers.

    So, if you truly have bad credit right now, it's going to create obstacles for you when applying for a home loan. Depending on how low your FICO score is, you may not even qualify for a loan. (You didn't mention exactly what your score is, so I can only speculate at this point.)

    Clearing Up Your Credit

    Let's move on to what you really want to know: How can you clear up a bad credit history before buying a home? While we are on the "clear" subject, I'd like to start by clearing up some of the terminology here (for the benefit of all readers). When people talk about their credit history they may be referring to one of two things:

    1. The financial decisions and actions they have made over the years.
    2. The way this financial activity is being reported on their credit reports.

    Item #1 leads to item #2. So both of these things must be considered when discussing the subject of how to clear up a bad credit history. The image below reinforces this. It shows how your financial activity is used to produce a credit score.

    Credit Reporting

    So your reports are used to compute your credit score. Mortgage lenders use this three-digit number when considering you for a loan. It shows how you have borrowed and repaid money in the past. So it helps lenders assess the risk associated with giving you a loan.

    The scoring models themselves are fairly complex (here's how your FICO number is calculated). But the thing you need to realize is that it all starts with you, and how you manage your debts.

    So if you want to clear up a bad credit history, you need to change the behavior that caused the problems in the first place.

    You Can't Rewrite History, But...

    Obviously, we cannot erase our financial past. But we can certainly correct the behavior that led to bad credit in the first place. For example, let's say that in the past I had a bad habit of neglecting my bills. I've missed payments for my credit cards, my car loan, and other bills for a period of several months. By law, this negative information can stay on my credit report for up to seven years.

    Now let's assume I've become more responsible with my bill payments. It's four years later, and I am planning to buy a home. I want to clear up my bad credit history so I'll have a better chance of getting a mortgage loan. What can I do?

    • I cannot change the past, so my delinquent payment situation will still be on my credit report (for a few more years anyway).
    • If my financial behavior has improved since then, and I haven't had any delinquent payments in several years, my credit report will reflect this as well.
    • It's still wise for me to request copies of my credit reports and clear up any errors that might be on there. Such errors can actually drag my FICO score down.
    • Most importantly, I should continue to pay all of my bills on time and make sure I don't rack up too much debt. Over time, this kind of good financial behavior will improve my credit score.

    That last item on the list is the most important of all. Even if you have some negative information on your credit reports, it will eventually go away. There are laws that limit the length of time those things can follow you. So if you are financially responsible in the meantime, your overall credit score well steadily rise over time. This makes it easier to qualify for a loan, and it helps you get the best interest rates at the same time. This is the real "secret" to clearing up a bad credit history.

    So what have we learned by all this? For one thing, we have learned that you cannot wave a magic wand and clear up your credit history instantaneously. You can (and should) review your credit reports for errors, and dispute those errors to have them removed.

    You can also change your financial behavior for the better. But the financial mistakes of the past can follow you for 7 - 10 years, depending on what they are. You can certainly improve your credit score over time, by changing that behavior. But you cannot change the past.

    Unfortunately, a lot of companies will lie to you and say that they can repair your credit and clear up any bad items from your credit history. Most often, this is just a scam designed to elicit payments from you.

    The only thing these companies can do is (A) help you remove errors from your credit reports and (B) offer advice on how to change bad financial habits. But you can do these things for yourself -- and for free.