Taking charge (pun intended) of your credit score

A year or so ago I went to a free presentation sponsored by the Overland Park (KS) Keller Williams office. The presenter, Rick Woodruff of Metropolitan Mortgage, explained how the US credit bureaus interpret credit activities and assign scores. Since that time, I have had numerous opportunities to assist clients in my role as a personal banker with understanding some of the basics to understanding credit. A couple of nights ago, I found my notes from that presentation and decided to summarize them and add a bit of commentary. I hope someone who reads this will find this a valuable addition to your financial/credit strategy. Although I am not an expert on the subject, feel free to pose any questions you might have. I welcome opportunities to go out and find answers.
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---What You Need To Know About Credit Scores---

FICO scores range from 300-850

The difference in costs between having a 760 or higher versus a 620-639 is astronomical. One recent example I saw resulted in $92,000 more in interest over a 30- year mortgage on a $100,000 purchase price.

The reason rates are lower for people with higher interest rates is that financial institutions see fewer delinquencies and defaults when high credit scores are present. Statistics show those with credit scores…

…higher than 800 will average only 1 default out of 100
…between 750-799 will average 2 defaults out of 100
…between 700-749 will average 5 defaults out of 100
…between 650-699 will average 14 defaults out of 100

Credit scores are composed of the following four measurements:
Length of history – 15%
Payment history – 35%
Amount owed – 30 %
Credit type – 10%

Length of history is worth 15 percent of the score. The longer an account has remained open, the more positive impact it can have, assuming the positives are not outweighed by late payments, defaults, etc. This is one reason it may not be advisable to close an account just because it is not being used. By closing it, the positive benefits to the credit score will eventually disappear – not to mention there will be a temporary hit on the score that accompanies the closing of a revolving credit account.

Payment history is weighted the highest at 35%. Make at least the minimum payments on time, every time, and this measurement can be your best friend. Have too many late payments, delinquencies or defaults show on your credit and they will remain on your credit for 7-10 years, depending on the type.

Amount owed, or credit utilization, also impacts credit scores significantly at 30% of the weighted average. Credit utilization is the amount owed as a percentage of the credit extended. If $2000 is owed on a total credit limit of $5000, this puts the credit utilization at 40 percent.

...If credit utilization is from 0-9 percent, no points are deducted from the credit score.
...If credit utilization is between 10-19 percent, 15 points are deducted.
...If credit utilization is between 20-29 percent, 25 points are deducted.
...If credit utilization is between 30-39 percent, 30 points are deducted.
...If credit utilization is between 40-49 percent, 40 points are deducted
...If credit utilization is between 50-69 percent, 75 points are deducted
...If credit utilization is between 70-89 percent, 85 points are deducted
...If credit utilization is between 90-99 percent, 100 points are deducted.
...If credit utilization is at 100 percent, 105 points are deducted.

As is evident from the above figures, it is very important to manage the amount of credit used on a monthly basis. Credit scores could wildly fluctuate if one month 10% of the credit limit is being used, with 70% being used the following month.

Credit type is given a 10% weighting. The best scores are awarded to those who have a mix of revolving accounts, installment accounts, and perhaps a mortgage.

---Tips To Improve Credit Scores---

Pay at least the minimum amount by the due date at the latest. Utilize automatic ACH payments or your bank’s online bill pay to reduce the chance that you will forget to schedule a payment.

Request a limit increase on your revolving accounts. If you keep your spending at the same levels, this increase will lower your overall credit utilization, which should raise your score. NEVER request your limits to be lowered as this will increase your credit utilization and drop your credit score (like a rock).

Verify all your credit accounts are reporting a credit limit. Some credit card companies will not report your credit limit, which can have serious impact on your credit.

---Mistakes To Avoid---

Closing old accounts or revolving accounts – your score will take a hit and you will eventually lose the benefit of the positive history.

Transferring your credit card balance to a new, lower rate card. Depending on how you do it, you could take three hits to your credit score: closing the old account, opening a new account, and a high credit utilization rate on the new card (we often are unsure how much credit will be extended until we receive the card in the mail).

Applying for credit jointly or being a co-signer. If the other person fails to manage the debt properly, makes late payments, maximizes the card, etc., there is no way to extricate your credit score from the situation.

Failing to pull your credit for fear of dropping your score. Seven inquiries are built in to the FICO model annually and the hit to your credit score after those seven is minimal.

Not obtaining new credit after a bankruptcy, a foreclosure, a tax lien or a bill turned over to collection.

...Late payments and collection accounts affect credit for 7 years.
...Chapter 7, 11, and 12 bankruptcies affect credit for 10 years.
...Defaulted government debts affect credit for 15 years.

Trying to live without any kind of credit product. At some point in your life, you will almost certainly need credit. Credit scores cannot be built in a day. They can only be built by opening accounts, staying within your means, building a history of paying on time, and utilizing the various types of available credit.