Getting your credit cleaned up and old debts paid is an important step in getting approved for a mortgage. However, just paying off debt won't get you the mortgage you want: You'll still have to prove to your lender that you can manage your finances, and this takes time. Maintain a good credit history for a few years and finding a mortgage at a decent interest rate will become a lot easier.
Mortgage Lending
Each mortgage lender has its own criteria for qualifying someone for a home loan and may offer several different types of loans depending on your financial situation and credit worthiness. Some lenders will work with you even if you have a recent history of credit problems, though there are often strings attached to this kind of mortgage, including a high down payment, fees and interest rates. If you are offered this type of mortgage, ask the lender about what it would take to get you a better deal. If the lender tells you that they need to see a longer history of on-time payments, you can often save a great deal of money by waiting a year and then reapplying for your loan.
Debt Reduction
Lenders don't like to see a lot of debt on credit reports, whether it is "good" debt for which regular payments are made, or "bad" debt with late payments or a default. Paying off any debt can help your credit score and put mortgage lenders at ease. However, just paying off debt won't automatically qualify you for a mortgage, as your lender is going to pay attention to your payment history and overall credit limits along with the total amount of your debt.
Credit Reporting
Your credit report contains a lot of information about your finances and use of credit. Some people mistakenly believe that if they pay off a debt, all records of the debt disappear from their credit report. However, federal law allows credit bureaus to keep negative information for at least seven years. If you ask for a loan of over $150,000 (such as a mortgage) a credit bureau does not have to suppress any portion of your credit history. This means that very old debts, even those that don't appear on your "regular" credit reports, may be visible to a mortgage lender.
Improving Your Credit Score
To improve your credit score, along with your chance at getting a good mortgage, continue to practice good financial habits. While paying off all your debt is a responsible thing to do, you also need to show creditors that you can manage access to credit. Use your credit cards each month to make a few purchases, keeping the balance on your card very low, then paying it off each month. If you can keep up a history of low debt and regular payments, your credit score will get better, qualifying you for a home loan.
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