Understanding your credit score…and tips on keeping it healthy

The importance of a good credit reportYou’ve been working diligently with a good realtor for several months and have finally found your dream home.  A price has been agreed upon, and the offer has been accepted.  You meet with your lender, and all the effort and excitement comes to a screeching halt… you can’t get the mortgage because of your low credit score.

 

Overview

 

In today’s world of commonly financed purchases, whether it’s a major acquisition of a home or a minor splurge at your favorite spa, understanding and managing your credit report and FICO score has become more important than ever.  The FICO score is used in more than 90% of consumer credit decisions and has become the global standard for measuring credit risk in the banking, mortgage, credit card, auto and retail industries.

 

Your FICO credit score is determined using information from accounts you have established with your lenders (think credit cards, car loans, students loans, mortgages). Your lenders supply information on the date that each account was opened, the loan/balance amount, and payment history to three major credit reporting companies: TransUnion, Equifax, and Experian. .   Your FICO score may be slightly different depending on the company that reports your credit, and the range is from 300 to 850 – the higher, the better. When you apply for a loan or mortgage, you give your lender permission to obtain your credit report and FICO score, and their decision (and frequently interest rate) is largely based on these numbers.

 

 

Managing your credit

 

Each of the three credit reporting companies are required to provide you with a free copy of your credit report once every 12 months, and it’s important to review these for accuracy.  To get your FICO score, you usually have to pay a small fee; these are considered ‘soft inquiries’ and don’t lower your score.  Once you obtain your reports, conduct a detailed review of each account to make sure balances, payment history, and number of accounts are correct.  You’re also entitled to a free credit report if your application for credit, insurance, or employment is denied because of information on it.

 

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[TIP: When a lender or business does a credit inquiry, it’s considered a ‘hard inquiry’ and can lower your credit score slightly.]

 

What affects your credit score?

 

Most of the negative events below will remain on your credit report for an average of 7 years.  While some financial disasters, such as bankruptcy, can’t always be avoided, there are other practices that can be improved.

 

1)      Late payments:  This is one of the first thing lenders consider when you apply for a loan, especially if it happens frequently.  Schedule payments ahead of time, and allow several days for mailed payments.  If you’ve forgotten to pay an invoice, call and see if the company will take a telephone payment that day.  Scheduling automatic deductions from your checking account, or automatic payments on your credit card are also methods to ensure prompt payments.

2)      Closed accounts:  Accounts that are closed, even those in good standing, also affect your record for up to 7 years.  Avoid having a large number of credit accounts; the next time a store offers you a 10% discount for opening a credit card account that day, which you’ll most likely never use, decline the tempting offer.

3)      Excessive debt: using more than 35% of a credit account limit consistently: Bumping up against your credit line and only paying the minimum payment each month identifies you as a highly leveraged risk.  Furthermore, if you add in the high interest rates being charged, you will never be able to pay it off with minimum payments.  Conversely, accounts that have been open for a long time, and those with high credit limits but low balances, can actually have a positive impact on your credit score.

4)      Collection accounts: Once a creditor sends an overdue account for collection, that record becomes part of your report.  If you pay it, make sure that the “paid collection” is noted on your report .  If you settle with the collection agency for less, that will also be noted.  Again, rather than allowing accounts to be charged-off or sent to a collection agency, work with the creditor to see if a reasonable payment plan can be established.

5)      Charged-off accounts: Rather than accepting the charge-off, try to work with the creditor on a repayment plan that might work.

6)      Foreclosure:  A foreclosure can drop your FICO score as much as 150 points.  By keeping accounts in good standing, and making all payments on time, you can start to improve your score within 2 years.  Wait at least 3 years before applying for a mortgage or other major loans.

7)      Bankruptcy: Chapters 7, 11, and 13 appear as public record items for up to 10 years after filing, although Chapter 13 filings are sometimes taken off after 7 years.

8)      Judgments:  small claims, civil claims, and child support judgments will be recorded on your report, as will tax liens.

 

After reviewing your credit accounts and scores, you may be surprised to find inaccuracies, as well as elements that just need overhaul and repair.  How to go about that? There is a right way and a wrong way to close accounts and report inaccuracies. Watch for the next blog on how to repair a bad credit report.