Posts Tagged ‘credit score’

Even if you’ve lived under a rock for the last several weeks, chances are you know that the economy has taken a dive. Stocks have plunged, credit is tight, and economists are predicting some gloomy months ahead. Most people believe that either we’re already in a recession or we will be very soon.

Now that we have the bad news established, let’s focus on some positive things — like a few tips that you can use to improve your credit score. And just so I’m clear, the economy doesn’t have to tank for these tips to be of use to you. Your credit score is your credit score, and for the most part, how it’s calculated doesn’t changed based upon the rise, or fall, of the economy.

Your credit score is broken down with approximately 35% of your score being based upon your repayment history and 15% of your score based upon length of credit history. Another 30% of your score is based upon amounts owed (e.g., accounts with balances, amount owing on accounts, etc.), with another 10% based upon the types of credit used and the final 10% based upon any new credit you may have.

With that said, focus on the things that you can do to influence your credit score.

1. Pay your bills on time. Although it’s hard to do if you lose a job, paying on time is very important to keep your score in good shape.
2. Keep your credit card balances low. Don’t use those cards. It’s tempting, especially when money is tight. But keeping that debt-to-credit-limit ratio low will help keep your score in good shape. It will also prevent you from being burned if your creditor lowers the balances on your revolving accounts. For example, if you owe $1,000 with a $4,000 limit, you’re only at 25% of your available balance. However, if your creditor lowers the limit, as some are doing now, then it drives your ratio up and your credit score down. Keep paying down those balances.
3. Don’t open new accounts. Don’t be tempted to go get that new car because you think credit is going to be tight in a few months. If you don’t have to have it, don’t get it. Tighten your belt — in the long run, you’ll be glad you did.

Recessions, especially this one, can be scary. However, by planning ahead and cutting back, you can get through it. If things get sideways, call your creditors, and try to work something out with them. It might not save your credit score entirely, but it will help some and save you a lot of aggravation in the end.

The title alone might surprise some people who mistakenly believe that a person’s credit score and also their credit reports are something issued by the government like birth certificates and Social Security cards.
It’s easy to understand the mistake — your credit report and credit score have almost as much impact on the lives of an American citizen as a government-issued document: Your credit report may make or break you in the job world, help or hamper you in your dream of attaining a home or auto.

So why and for who was credit scoring first developed? Fair Isaac was started in 1956 as a way for businesses to make better credit-granting decisions and billing. In 1970, the company developed its first general credit card scoring system. In 1975, it introduced its first behavior scoring system to predict credit risk related to existing customers, and in 1981, Fair Isaac successfully marketed its scoring system to the existing credit bureaus: Equifax, TransUnion and TRW (now Experian).

When a consumer’s credit history became available through modems and then later the Internet, mortgage companies were able to pull a customer’s credit score, and it was sold to the banking industry as a way to save time in making credit decisions; indeed, a person’s credit score became the first line of defense for underwriters. In most cases, the data which produces the score, i.e., the credit report, is no longer reviewed.

Which would be better — government bureaucracy with all its red tape to handle your credit or private companies? The Fair Credit Reporting Act, which monitors the activities of credit reports and the scoring system, was implemented to protect consumer privacy from the lax approach of one credit bureau in particular. In the 1960s and early 1970s, Equifax was attacked by Columbia University Professor Alan Westin, who laid into the bureau for its cavalier attitude toward the accuracy of its information on consumers, and for giving out that information to practically anyone who asked for it.*

Currently, the specifics of what goes into the available scoring models is “classified” information — would the government be more transparent if it had been running the credit game? I would hazard a guess of “yes,” as this type of regulation would not be considered military secrets or national security. The developers of the credit scoring system argue that “transparency” would allow consumers to manipulate the scoring system and “render it useless.” I’m not sure I agree — a late paying record or bankruptcy cannot be “manipulated.”

I see far too many abuses of consumer data by the bureaus in the name of increasing profits by cutting corners; computer-automated error disputes, lack of staffing and minimal review (if any) of consumer-provided documentation. It’s common knowledge that fully 60%+ of consumer credit reports contain errors — if the government ran things, disputes might take weeks to resolve, but most likely a human being would be involved.

What’s your opinion on the effectiveness of our current credit reporting system?

Footnote

* Wired Magazine: http://www.wired.com/wired/archive/3.09/equifax.html

You may have heard that credit card companies will “ding” your credit report if you pay off your balances, harming your credit rating. This is simply untrue. One of the best ways to improve your credit score over time is to keep your credit card balances low (this goes for other “revolving” credit accounts too).

What is Credit Utilization Ratio?

The reason for this is that 30% of your FICO credit score is calculated using the “amounts owed.” This makes it the second most important criteria after payment history. So keeping low balances helps because the credit score formulas use a “credit utilization ratio,” which is the current unpaid balance on your accounts divided by the credit limits on those accounts. In other words, credit utilization is simply how much of your credit limit you’re using. The higher your credit utilization, the lower your credit score. The opposite is also true — reducing your credit utilization ratio will eventually increase your credit score (everything else being equal).

Obviously, there are two ways to reduce your credit utilization: by paying off your balances or by increasing your credit limit (if you can do both, you’re even better off). Don’t be fooled into thinking that closing accounts will help; canceling established credit cards that are in good standing will hurt your credit score because it will decrease your overall credit limit.

Another very good — and obvious — reason to pay off your balances is that it’s the best way to live within your means and avoid paying high interest rates on balances that just eat up more of your hard-earned cash.

So, the lesson here is to pay off your credit card balances every month. It should help your credit score and keep more money in your pocket. And higher credit scores should result in lower interest rates for credit.

We all know that improving your spending habits will improve your credit score, but what we really want to know is, just how long will it take to reflect favorably on our credit report?

Before I answer that, let’s first define what improving your spending habits means in relationship to your improving your credit. Essentially, we’re talking about you spending responsibly so that you live within your means, pay your bills on time all the time, and avoid incurring too much debt and maxing out your credit accounts. Improving your spending habits in this way is most likely going to relate to two specific areas of your FICO credit score — payment history and amounts owed. Approximately 35% of your credit score is based upon your payment history, and 15% of your score is based on the amounts owed on your accounts. By paying your bills on time and keeping the balances on those credit cards low, arguably at or under 30% of the available balance, you have the opportunity to influence about 50% of your credit score. The other 50% of your score is determined by things such as your length of credit history, new credit and the types of credit that you have.

So the question still remains: Once you’ve committed to making the necessary changes, how long will it take to see results?

Most creditors report to the credit bureaus every month. Therefore, if you pay down the balance of an account, the new balance should be reported to the credit bureau over the next month, and if your credit score is improved, you should see such improvement. While it’s also true that the timeliness of your payment will also be reported on a monthly basis, they’re really looking at your payments from a historical perspective over a period of time. Therefore, improving your score based on your payment history will likely occur over a period of several months. Even still, there’s no time like the present. Start improving your spending habits to improve your credit score. You should begin to see results over the next 30 to 60 days, but remember to be patient, because significant improvement will take a little time