Credit Scoring

Mortgages, car loans, credit card offers, insurance rates, rental applications, home equity loans & lines of credit, retail store accounts, etc all use credit scores as a factor in determining your terms.  With today’s low rates combined with tougher lending rules and restrictions, it’s more important than ever to make sure your credit is top notch.  A difference in just a few points on your score can make the difference between getting that loan or not, and the pricing can vary dramatically between small bands of variance, costing you thousands of extra dollars over the life of your loan!

Although seemingly complex and often confusing, your credit score is essentially based on five key factors, the first and most important being payment history.  35% of the score is based on how you handle your debt obligations.

Please note that paying a past due balance on a collection or charged-off account does NOT increase your credit score under most circumstances (due to flaws in the credit scoring software) and may even have the opposite effect more times than not (call me if you need a referral to a mortgage broker who can go over this with you in detail).

The second key factor determining your credit score is based on credit utilization patterns.  30% of the credit score is derived from your revolving balances carried on accounts as they pertain to your debt utilization ratio. Revolving credit cards make up a very significant portion of what ultimately determines your credit score.  Your total revolving credit utilization ration is calculated as follows:

(Total Open Revolving Credit Card Debt divided by Total Open Revolving Credit Card Limits) x 100 gives your Credit Card Utilization Ratio.

Example: ($15,000 of open credit card balances divided by $75,000 of available credit card limits) x 100 = 20% Credit Card Utilization Ration (debt ratio for short).

The closer to zero your Credit Card Utilization Ration is, the better your credit score.  If you are able to do so, you should pay off or pay down your credit balances to enhance your score.

A second step you can take to improve your credit scores is to lower your debt ratio by raising your credit card limits. CAUTION:  You need to approach this matter with due care.  Call and ask each credit card company if they will increase your card limit based on a review of your payment history with them only.  INSIST that you do not want them to pull your credit report and thereby create an inquiry that will damage your score.  Some creditors will do this, some will not.  I do not suggest letting them pull your credit if you plan to make a credit purchase in the next six months since the inquiry will decrease your score.

15% of the score is derived from the average length of time you have had credit.  The longer an account has been open, the better.  Never close a credit card account; leave it open with a zero balance.  You actually reduce your score by closing older accounts as your average account age will not increase in the future as quickly.

10% of the score is derived from the mixture of credit you have on your credit report.  To maximize this area you want to have a mortgage, a car loan, and a few credit cards.  The magic number of credit cards to have is three but it is never a good idea to close credit cards to get down to that number because closing the card does more damage than the increase received by having fewer cards.

10% of the score is derived from the number of times you apply for credit.  There are several types of inquiries, but the only kind that hurt your credit score are those linked to an application for credit.  In some cases, even asking for a credit limit increase is considered applying for a loan and can trigger the wrong kind of inquiry when the bank runs your credit as a result of the credit limit increase request.  Pulling your own credit report online or directly through the credit bureaus is considered a personal inquiry and does not hurt your credit score.  Anytime you receive a pre-approved credit offer in the mail, it is considered what the industry calls a “promotional inquiry” and will not affect your score either.  Lastly, a current creditor of yours looking at your credit report without you asking them to is considered an “account review” inquiry and has no effect on your credit score.

If you need a referral to a mortgage broker to discuss your credit score in detail, please give me a call.