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Your Credit is a Window on Many Worlds

Hoover Financial AdvisorsJuly 13, 2015

Debt / Credit Protection

Too much credit? Too little credit? No credit? Good credit? Bad credit? There are so many considerations when protecting and managing personal and business credit. Lenders generally rely on five key factors when evaluating individual or company credit worthiness. Sometimes called the 5 Cs, there are:

Credit History
Is a credit history established and is the score good?

Capacity
Is income sufficient to carry current or more debt?

Collateral
Does the collateral one is borrowing against have a high enough value? This applies to secured credit card or loan requests. A secured credit card can be used wherever Visa is accepted. The difference is, a security deposit is required to fund the collateral account.

Capital
Are there savings, investments or other assets that can be used as a secondary repayment source in case of an emergency, such as unemployment?

Conditions
Does the economic environment or loan purpose make it a risk?

Your credit score influences not only the decision to allow or deny a credit card, auto loan, mortgage or various payment programs. It can be used to determine interest rates, as well. The greater the risk, the higher the interest charged. In addition, high scores are certainly preferred, but they cannot predict if someone will be a good or bad customer.

The most widely used credit scores are created by Fair Isaac Corporation or FICO. Ninety percent of top lenders use this resource to help them make billions of credit-related decisions every year.  A person with credit has a FICO score at each of the three credit bureaus: Equifax, TransUnion and Experian. Each score is based on information the reporting bureaus keep on file about individuals with various types of credit. Data and scores may be different at each one.  Base FICO scores have a 300 to 850 range. Although many lenders seek FICO scores when making decisions, there is no single cutoff score used to calculate interest rates.

FICO scores are ascertained by reviewing credit bureau reports. The reporting agency provides up to five reasons that most heavily influence the score. These reasons are usually negative, because they explain why the score is not higher. Credit scores are based on payment history, debt usage, the age of credit accounts, the different types of credit accounts on credit reports and credit inquiries. Not every lender places the same importance on each component. Credit age may be essential to one loan company, while debt usage could weigh heavily on the decision of another. Furthermore, different lending institutions frequently use one credit score for mortgage business and another for auto and other loans.

What is most important to a majority of Americans is how to acquire and maintain good credit. Potential lenders look for risk signs. These include payment history (late payments); credit usage (using more credit than lenders feel borrowers can reasonably afford to pay); and account balances (owing debt on a large percentage of accounts causing lenders concern an individual is living beyond their means).

No past due amounts raise credit scores. No collection accounts or negative public records also help to raise scores. Another positive is having accounts for a number of years. Accounts opened 40 or more years ago are considered best. If an account is only seven years old, credit history is short and any account opened less than three years ago is too little.

Most credit scores, including FICO, operate within a range of 301 to 850. If you know your score, you can see where you stand on the following scale:

  • Excellent Credit – 781 to 850
  • Good Credit – 661 to 780
  • Fair Credit – 601 to 660
  • Poor Credit – 501 to 600
  • Bad Credit – Below 500

Those with higher numbers are more likely to be approved for credit, get lower interest rates and may even receive discounts on insurance. However, just because you pay your bills on time, don’t assume your credit rating is excellent. The only way to know is to review scores on a regular basis.

If you wish to ensure good credit, there are some simple ways to start or to improve existing habits. Some are obvious, but should not be overlooked.

  1. Establish a positive credit history by opening and responsibly managing a secured credit card.
  2. Consider a co-borrower on a loan.
  3. Get current on any missed payments. Delinquent accounts may stay on credit report files for up to seven years.
  4. Always pay bills on time with at least the minimum amount due.
  5. Stay within credit limits on cards or lines of credit.
  6. Review credit scores annually and report discrepancies promptly. Free reports can be ordered by linking to AnnualCreditReport.com or calling 1.877.322.8228 and following instructions.
  7. Pay down high interest rate debt first.
  8. Don’t open new credit accounts you don’t plan on using.
  9. Set a monthly budget and maintain it.
  10. Consider other income sources not listed on credit applications.
  11. When possible, consolidate debt into a lower interest rate account.
  12. Pay more than minimum amounts on monthly bills.

Other issues that can affect credit scores are identity theft and credit card cancellation. Investigate Identity Theft Protection programs at your bank or discuss it with your HFA advisor. Credit card closing may be a surprise. Just because you cancel a credit card does not mean payment information automatically comes off your report. Positive credit data can stay on reports indefinitely, which should not cause concern. By federal law, negative information must be removed after seven years. Depending on total available credit, closing a card with a high credit limit could hurt your credit score, particularly if you have high balances on other cards or loans. To close card accounts with no negative impact, you must have zero balances on your credit report for all active credit cards. To clarify, if you have zero balances, your credit utilization rate is also zero and you can’t raise it and potentially hurt your score by closing one or more active card accounts.

To begin the process of building good credit, order your free report. (See number 6). Be sure you contact the proper source. Only one website is authorized to issue free annual credit reports. Imposter sites are not part of the legally mandated program. There will undoubtedly be strings and fees attached. All you need to receive a free credit report is your name, address, Social Security number and date of birth. If you have moved in the last two years, you may have to provide your previous address. You could be asked to supply a piece of information only you would know, such as the amount of your monthly mortgage payment.

If you request your report online, you should be able to access it immediately. If you order by phone, it will arrive within 15 days and mail ordered reports will be sent within 15 days of receipt. If you prefer to buy your credit report from one or all of the three credit bureaus, contact them directly at: Equifax, 1.800.685.1111 or Equifax.com; Experian, 1.888.397.3742 or Experian.com; TransUnion, 1.800.916.8800 or transunion.com. If you wish to compare scores, order all three reports at the same time. However, to keep track of changes or new information, stagger you orders.

Credit can be a wonderful thing – if it is good. For example, someone with a credit score of 840 is just 10 points below the highest possible rating. That person could pay more than $90,000 less on a 30-year fixed rate mortgage for a $300,000 home. Be sure to take charge of your credit health and keep your scores strong. The rewards are ample.

Information for this blog was obtained from Wells Fargo; AnnualCreditReport.com; Federal Trade Commission Consumer Information (consumer.ftc.gov); and creditcard.com.