Understanding Your Credit Score
Being a loan officer I pull quite a few credit reports every month. Every once in a while, I have that client with a not so good credit score but they just had a hard time and the past and would like to start moving forward, and getting back on the right track to improving their credit score. I find myself educating them on the pros and cons of a credit report and advising on the best solution for their specific situation. One unusual question a client had asked me the other day was, “why is a good credit score so important?” jokingly of course.
Well let’s break that question down and answer it for others you may not thing that having a good credit score should be that important..
Most important reasons to keep your credit intact.
- Student loans
- Eligibility for jobs/career advancement
- Car loan
- Credit cards
- Home loan
- Economic value of a good credit score
When you apply for a mortgage loan your credit score plays a factor in determining your interest rate.
An interest rate difference between 4.5% vs. 5.5% on a $200,000 30 fixed rate mortgage = a cost savings of $43,994.00!
How is your credit score calculated
HOW IS YOUR SCORE CALCULATED
10% – Types of credit
10% – New Credit
15% – Length of credit history
30% – Amounts owed
35% – Payment history
Payment history has the largest percentage of points affecting your credit score. This isn’t much of a surprise considering mortgage lenders use your credit score to evaluate how likely (or unlikely) you are to repay your debts.
You get a check mark every time you pay on time.
- Lasts 2 years
- Each payment made on time can increase your score a couple points.
You get a negative mark every time you are late.
- Lasts 7 years
- Can drop a score up to 120 points. (OUCH)
Your payment history also accounts for actions taken against you for non-payment, such as the number of items you have in collections. Debts that are in collections make and even more severe mark than a regular delinquent payment, and typically remain on your report up to seven years.
Having large balances remaining on your line of credit will also give a negative effect on your FICO score. It is best to use only 30% of the given balance, along with making on time monthly payments to keep your credit score up to par.
Which credit card is the best to get?
- No limit Card
- Secured Card
- Unsecured Card
How much should I spend on my credit cards?
- The lower your balance the better!
- Your score is not decided by how much you spend, but how many months you spend.
- One small charge each month is just as good as 100 charges each month.
Length of Credit History
The length of time you have a debt is calculated by taking an average of your open and active accounts. A perfect length of credit history is normally 25 years, so try your best not to close any accounts. Every time you close an account you lose the length of credit history on this account as well as lowering your credit score by a few extra points. The best way to ensure a healthy length of credit history is keeping your old credit cards, even if you don’t use them. Keep in mind that closing a card does not “remove” any negative information associated with the account from your record until 7 years after the date of last activity.
Opening new credit does have it’s advantages and disadvantages. You first apply to open the line of credit to help your score but you will lose points for inquires: 2-5 points on hard pulls for the first 6 months. You lose 0 points for soft pulls, which are mostly the times when you pull your own credit report.
Once the new line of credit has been opened, your score will drop about 20 points for the first 30 days, but no need to panic. Most of the points will be given back to you after having the line of credit opened for 90 days. During a mortgage loan application process, never apply for new credit cards, an auto loan, or any other item that requests your permission for a “credit check” unless directed to do so by your loan officer, while you are under contract for the loan.
Types Of Credit
Having a good mixture of credit types will definitely get your credit score cooking, rising the best it can be. But try not to have too many credit cards. An ideal mix or credit would be one of each of the following:
- A credit card with a limit
- A credit card with no limit
- A personal line of revolving credit (furniture store, bank revolving account, etc.
- An installment line of credit, student loan, unsecured personal loan, etc.
- Auto loan
- Mortgage loan
Common Pitfalls in Fixing Your Credit
There are plenty of consumers who wish to face the daunting task of improving their credit score on their own, but without knowing , they only make it worse. Here are some of the most common pitfalls that a person can make.
- When paying off collections accounts, this will lower your score for the first 30 days but will increase in 60 days after the debt balance is $0. This is only because an old debt had be brought current. The only time paying off an old collection increases your credit score is with a letter of deletion from the credit bureaus. Once the collections debt is removed from your report all together, the score will go up.
- Cutting up and closing your old credit cards will also lower your score as well as lowing your length of credit history. Try to cut up your cards and leave the account open. Especially when applying for a mortgage loan because some leaders do require open trade lines.
- Time only heals if you continue to build positive credit, in fact, many people find their scores go down over time because they fail to establish and use credit on a consistent basis after paying off their debt.
- Disputing items can be a bonus for your credit. Again, if you are in the mortgage loan process, this is the only way it will be a negative for you. Often a dispute can prevent a loan from being approved
- It is important not to dispute items that are improving your score or are neutral trade lines. Also, seek the advice from a professional – (just as you would consult a mechanic for difficult car repairs)
Why Is My Score Always Different?
If you pull your scores from Credit Karma, Credit Report.com, Car lender, or even a financial institution, you will notice that they all will show different scores. This is because there are different algorithms with all of these programs, used to calculate a FICO score for a specific purpose.
- Mortgage scores (Mortgage specific FICO scores)
- Auto loan scores (auto specific FICO scores)
- Credit card scores (credit card specific FICO scores)
- Online scores (do not use FICO scores at all!)
No person can take on more debt without pulling an industry-specific FICO score only, and using the information from one, two or all three bureaus: Experian, Transunion, and Equifax. A perfect score for FICO is usually close to an 850 depending on the specific score and a perfect score online could be whatever the website wants (even the bureaus scores are not FICO generated and are “fako” or inflated scores)
Where Can I Check My Credit Score
Great place to view your score:
$1 credit report
Does not lower your score from inquiry
Scores are similar to mortgage industry
$14.95/month optional monitoring service (just call and cancel in 14 days if you do not want this)
Annualcreditreport.com – you can check your report for free – but you don’t get scores .