LETTERS From CAMP Rehoboth |
CAMP Money |
by Chris Beagle |
Good credit? Don't be so sure!
As kids, we learned that if we brushed our teeth, we wouldn't get cavities; if we looked both ways before crossing the street, we wouldn't get hurt; and if we studied in school, we would get good grades; logical outcomes to the simplest of life's many lessons. Somewhere along the way, we also learned that by paying our bills we would be rewarded with good credit. As a Loan Officer, I can't tell you how many times I hear the response, "I have great credit! I pay off my cards every month." But if you think that doing so will help your credit, read on, because sometimes life throws us curves, and logic, sadly, gets tossed out the window. Your credit score tells the world how likely you are to pay back what you owe. The Fair Isaac Corporation developed the most commonly used scoring system, known as the FICO score, which assigns you a rating between 300 and 850, the higher the better. It considers factors like how many credit cards you have, how long you've had them and how quickly you pay your bills. Specifically, your FICO predicts the chances of a 90 day default in the next 24 months. Contradicting common logic, it's not an 'award' system but a predictive score that tells creditors how likely you are to pay them back. The exact formula for determining a FICO score is not released to the public by Fair Isaac. Sounds like a contradiction, right? In analyzing such factors, however, the following breakdown may shed some light on just what is important in making the determination: Payment history 35% Amounts owed 30% Length of credit history 15% Types of credit used 10% New credit 10% Until a few years ago, a score of 620 or more was good enough to be approved for most, if not all, credit. A score of 700 was considered 'two-thumbs up,' as an unofficial industry standard. In reaction to the lending crisis of 2008, however, the bar was raised three times, to 680 in February, 720 in April, and 740 in August. Now, interest rate adjustments begin at 739, with every 20 point drop adding another adjustment. Scores of 739, 719, 699 and 679 can leave the prospective borrower wondering exactly what made the difference. What once was great is now only good. Perhaps out of necessity or simply a proactive reaction to this, many people have become increasingly vigilant about their credit, and have taken action into their own hands. Unfortunately, much of what may be perceived as helpful may actually be counterproductive. The three things most commonly mistaken as helping one's credit are: Closing credit cards Not using credit Consolidating cards Closing credit cards can have a negative effect on your score because it changes your credit utilization ratio, the ratio of your incurred debt to the total credit available. Simply put, the higher the ratio, the worse for your credit. The length of your credit history is very important, so if you need to close a card, close the one most recently opened. Or, keep all of your cards open and simply rotate their use monthly. As long as you don't have high balances or missed payments on any of your cards, there is no credit score penalty for keeping multiple cards open. Instead of closing credit, you should decrease the amount of available credit used. This can be done by paying down balances or increasing credit limits. The goal is to keep balances as close to zero as possible and definitely below 30% of the available credit limit. Next, not using credit is usually thought to be good for one's credit. From the credit side of the equation, consider this, unused credit means FICO has no history to track. Without history, FICO has less reason to believe that a borrower will pay, simply because there is no established pattern one way or the other. If you don't think you can trust yourself with a credit card, consider getting a card with a low limit, and using it sparingly. If you want to be considered for a loan, credit-rating agencies need proof you are responsible with borrowed money. Finally, consolidating your credit onto a new card is considered to be a new account, while the established credit disappears from your history. Any cards you took balances from and closed are erased and your score will go down. Tons of credit companies create ultra-attractive, low-interest, marketing schemes designed at luring borrowers with the promise of huge savings. While paying less is a valid consideration, if you are at all concerned with your credit score and are considering the major purchase of a home or auto, know that your score will be negatively impacted. As with so many things in life, timing is everything. Having too many accounts has a negative impact on your credit, but if you've had the accounts for 24 months or more, you should know that consolidating or closing credit is worse than keeping and leaving it unused in an open status. Be wise. Know what makes a difference in your credit score and, most importantly, live by it!If you'd like to discuss your credit, feel free to contact me. I'm happy to offer advice so that you too can be sure about what makes "good credit." Chris Beagle is a Senior Loan Officer at Fairway Independent Mortgage Corporation. For more information, contact Chris at 302-260-7090. |
LETTERS From CAMP Rehoboth, Vol. 19, No. 07 June 19, 2009 |