Do You Need To Have Credit to Get Credit?

By Gina Pogol
Mortgage Credit Problems Columnist

Brandy Asks: Dear Gina, I had really bad credit a few years ago and filed a Chapter 7 bankruptcy. I have been so gun-shy about applying for credit (too embarrasing!) that I have not rebuilt my score much. It's only 610 five years after the bankruptcy. I've been told that I must look for loans for people with bad credit to reestablish myself before I can apply for a mortgage. What is the best way to do this?

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Gina Says:

Dear Brandy,

There is something to be said for reestablishing credit to improve your score after a financial debacle, but there's also something to be said for restraint. While companies do make credit cards available to people with bad credit, they may come with some pretty ugly provisions. First, these cards, both secured and unsecured, are very expensive. In the past, one card with a $300 limit came with a $279 balance on it just from the fees. Now, the CARD Act restricts fees to 25% of the card's balance--$100 for every $400 of credit offered. So, sub-prime card companies have responded--in one case, by taking the interest rate up to 79%!

There Are Better Ways to Solve Your Mortgage Credit Problems

First, you can improve your score for free by becoming an authorized user on one or more accounts owned by family members or friends with good credit. You don't actually use the credit, so there's no chance that you can get into trouble with it. It's best, in fact, if you don't even know what company the account is with or what the account number is. You aren't responsible for paying the bill and you won't be using the account. but you do get the benefit of a nice clean trade line and an improvement in your credit history.

FHA Doesn't Hold it Against You if You Don't Use Credit

Bad credit lenders only look for derogatory events in the last twelve or twenty-four months when evaluating a mortgage application, so your lack of recent credit history shouldn't faze them. And FHA states very clearly in its underwriting guidelines that the fact that you have decided not to reestablish credit should not be held against you. I quote:

A Chapter 7 bankruptcy (liquidation) does not disqualify a borrower from obtaining an FHA-insured mortgage if at least two years have elapsed since the date of the discharge of the bankruptcy. Additionally, the borrower must have re-established good credit or chosen not to incur new credit obligations. The borrower also must have demonstrated a documented ability to responsibly manage his or her financial affairs.

To verify that you are now managing your debts properly, the bad credit or FHA mortgage lender pulls what's called a non-traditional credit report. Your payment history is documented for your rent, utility bills, and any other installment debt that you have. Your bank accounts are scrutinized for bounced checks. And you may want to write a letter of explanation, telling the underwriter briefly why you went bankrupt and how your decision not to use a lot of credit is part of your plan to keep that from happening again.

Finally, FHA does allow people with credit scores of 610 to get mortgages, but many FHA lenders require scores of 620, 640, or even 660. Contact a bunch of lenders (the form on this site is a great place to start) and ask upfront what the minimum credit score is for an FHA loan or bad credit mortgage.


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