I'm not most lenders though. To protect them from unpleasant surprises, I reviewed their credit report more deeply and saw a problem lurking in their future. They had been diligently following Dave Ramsey's Financial Peace process and, over the previous several months, had paid off and closed all debt under the husband's name. While the wife had a couple of credit cards still open, the husband had closed his last trade-line in December.
So why does this matter, you ask? Good question, and one I had to answer for this sharp young couple as well. Let's take a minute to talk about how trade line's impact credit scores.
The 6 Month Rule
Mortgage lenders use the FICO model to pull credit scores for potential home buyers. This FICO model gives the buyer a score based on several factors, such as balances, length of credit history, and historical late payments. The lender uses that score to gauge the type of credit risk they are taking with that client.
One key thing that many people don't know about credit scores is that FICO won't give a score to a person unless they have recent, active credit items. You could have had all the credit history in the world two years ago, but if you've paid it all off and closed it down, your score goes away with it.
So what is considered recent? Six Months. The current FICO scoring model requires that you have one undisputed account that has been reported to the credit bureau within the past six months or you will not have a credit score.
When You Need A Score
This raises the question then, do you actually have to have a score? Not always. For a conventional mortgage loan, you do need a credit score. FHA financing will allow a buyer to get a mortgage based on a 'non-traditionial' credit report though. A non-traditional report can be created for a lender by verifying things that aren't normally reported to the credit bureau, like rent payments, car insurance payments, utility bills, etc. If a buyer has a 12+ month history of several of these types of items and they've paid them on time, they could likely qualify for a FHA loan even without a traditional credit score.
FHA's Downfall With Ramsey
Even though a FHA mortgage would fit with a Ramsey lifestyle, David Ramsey would never encourage a FHA loan for one primary reason - mortgage insurance. While Ramsey's preference is that people save up enough money to pay cash for their home, he has said that he can understand getting a mortgage sometimes. His rule is that you get a 15 year term though and put at least 20% down to avoid mortgage insurance (MI).
With the changes to FHA's mortgage insurance taking effect later this year, all FHA loans will have monthly mortgage insurance. It won't matter if you take a 15 year term or if you put 20% (or 50%, 60% or even 90%) down. All FHA loans will have monthly MI for at least 11 years. If the borrower puts down less than 10%, the monthly MI will stick for the life of the loan. Seeing Ramsey hates MI, he'd very likely disapprove of this option.
Final Advice To My Buyer
So where does this leave my clients? I personally dislike debt and wouldn't encourage a buyer to rack debt up just for a credit score. This buyer's score is going to disappear in June, though, if he doesn't take some action. Seeing he doesn't have enough saved yet to pay cash for the home and FHA is not a good choice, he'd be wise to take some minor steps to keep his score intact.
The easiest thing would be to add himself to his wife's credit cards. They already exist so there is no 'new' debt being incurred. If those cards are gone now too, though, then he will want to take the further step to open something new in his name to keep his score in place.
The key word here is OPEN. Not use. Not carry a balance. Simply opening a credit card and, at least once every 6 months, doing something with it that would make the credit card company report the activity, should keep his score intact. It can be a $1 charge for a pack of gum that he pays off as soon as the bill arrives. Truly - carrying debt balances is not needed for this. Taking this step will help this home buyer stay true to the heart of the Ramsey principles while giving him the credit score that leads to better mortgage options when the time comes to buy his home.