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How
Lenders Keep Score
One
false move can follow you around for seven years.
There are five major factors which credit bureaus consider
to determine your credit rating. Read below to be sure
you aren’t caught by surprise when you plan to
make your next major purchase.
1.
Past payment history. Your payment punctuality
weights heavily (about 35%) on your credit score. The
more recent your tardiness, the more points you sacrifice.
Your credit report will show whether you are 30, 60,
90 days or more late with a payment. A history of late
payments on several accounts will cause more damage
than late payments on a single account. On the flip
side, by paying your bills consistently on time, you
can greatly improve your overall score.
2.
Amounts owed. Add up all your outstanding balances
and compare the number to the amount of credit that
is available to you. If you are reaching -- or exceeding
-- your credit limits (does the term “maxing
out” mean anything to you?), lenders will get
antsy. This measure of your credit karma makes up 30%
of your credit score. At the same time, even if you
aren’t anywhere near maxing out your accounts,
you want to make sure that the credit extended to you
isn’t out of proportion with your income. Interestingly
enough, your score can be significantly affected depending
on where you are in your billing cycle. You can add
20 points to your score the day after you pay your
credit card bill (even if you pay in full every month).
3.
Length of credit history. Fifteen percent of your
credit score is determined by how long you’ve
been using credit. Obviously, the longer your credit
history, the more favorable lenders will see you. Your
score in this area also takes into account how long
it has been since you used certain accounts. So just
having an idle card for 10 years won’t necessarily
raise your score. Don’t open a lot of new accounts
at once to establish a credit history. That strategy
will lower the “average account age” on
your score, which could affect your score negatively.
4.
Amount of new credit. Each time you apply for new
credit, an inquiry shows up on your report. Red flags
start waving when you take on more credit – or
even just apply for new credit – in a short period
of time. This is one area where good habits can work
against you. If you prove yourself a reliable bill
payer, charge card issuers will be quick to offer additional
credit.
Future lenders, however, may not take kindly to all
this readily available credit. Some fear you will use
it to go on a spending binge, quickly undermining standard
calculations for determining how much additional debt
you can shoulder. This area of credit management carries
a 10% weight on your overall credit score.
When
you shop for new credit (such as a home loan), try
to do so in a concentrated period of time. FICO
distinguishes a search for a single loan and requests
for many new credit lines (note that requesting a copy
of your own credit report does not affect your score).
If you’ve had trouble with this area in the past,
you can boost your score by re-establishing credit
(not too much credit, though!) and making on-time payments.
5.
Types of credit. Types of credit include credit
cards, retail accounts, and installment
loans (like car loans and mortgages). Your use – or
overuse – of these has a 10% impact on your overall
score. Though you may be tempted to show what a good
borrower you are by using all types of credit, more
is not always better in the eyes of credit scorers.
And if you have no credit history, lenders will consider
you a higher risk that someone who has managed credit
cards responsibly.
Let’s
Pretend
What happens to your credit score when you max out
or miss a payment, or even pay your balance in full?
Scenario
1: You pay all your bills on time every month.
Paying on time can up your score to 727. According
to FICO, more than 68% of the U.S. population did not
miss a single credit payment in the recent past. In
other words, it pays to be punctual.
Scenario
2: You space out and forget to pay all your bills
every month. Watch your score go from 707 down
to as much as 582. Yikes! If you tend to be forgetful,
you may want to set up automatic bill pay – at
least for your credit cards and other loans. Nearly
one-third of the borrowing public has evidence of serious
delinquency information reported on their credit file.
Scenario
3: Feeling generous, you pay down about one-third
of your outstanding balances. Sorry, that’s not
going to have as big of an impact as you might think.
Your score will hover in the 707 to 727 range. The
national average of total amount owed on non-mortgage-related
credit obligations by U.S. consumers is around $11,000.
Still that doesn’t factor in the exorbitant interest
being paid for the borrowing privilege.
Scenario
4: You go on a spending bender and max out all your
cards. That’ll hit you where it counts – in
your wallet and in your credit score, which could dip
down into the 630s.
Scenario
5: You apply for and receive a $3,000 line of credit.
All other factors being “normal,” this
won’t affect your score too much (it’ll
fall somewhere between 697 and 717). For the average
consumer, the most recent account opening was 20 months
ago.
Scenario
6: You transfer a $5,000 balance to a lower-interest
card. Good for you, if you’re doing so to pay
off your debt more quickly. In the long term, this
move will pay off in spades. In the eyes of FICO, it
doesn’t much matter, though, since you still
owe the same amount of money, regardless of what account
you moved it to. In this case, your score will be anywhere
from 692 to 722.
It
may seem complicated, but you don’t have
to be an accountant to keep a decent credit rating.
Paying bills on time, not over-spending, and keeping
your extended credit within reasonable limits are things
all of us can do, and we don’t need a complicated
formula to figure it out. Do these things, and it’s
likely your credit will remain “clean,” and
you won’t have trouble when you want to make
your next major purchase.
The Bottom Line, June/2003 issue
-- information reprinted with permission from Robin
J. Walling, EA
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