Credit Scores: The Silent Killer

Larry C. Nelson
KCB Information Services
The silent killer—that may be a little dramatic. However, if you have a bad credit score, you may feel like you are dying slowly. Interest rates are killing you. You can’t pay your high insurance premiums, even if you could get insurance. Deposits and down payments are more than you can afford. You never seem to get a good deal or a break.

On the other hand, if your credit score is high, you are probably living on easy street. You have low interest rates on credit cards, car loans and home loans. Your insurance premiums are affordable, deposits and down payments are low or not required and you are given the best deals and offers.

It may seem that your life, or at least your lifestyle, is decided by a three-digit score from 350 to 850. (The higher the score, the better.) One company, Fair Isaac, has created the industry standard. Most financial institutions use Fair Isaac, as does Fannie Mae, Freddie Mac and most mortgage companies.

What is a Credit Score?

A credit score is a mathematical calculation of your credit report information. There are many types of scores and several companies creating them. Each credit bureau has its own. Some scores are formulated for specific industries, such as auto, credit union or personal loans.

A credit score looks at public records, trade lines and inquiries. A trade line is the information reported from one creditor. It includes the type of creditor, type of account, who is responsible for the account, date open, date last paid, current status, history of payments, original and current balance, monthly payment and sometimes a statement about the account. It does not look at age, sex, race, income or addresses, current or previous.

Open accounts, accounts paid within the last two years, inquiries within the last two years and public records are counted or “scored.” The scoring starts with this formula:

Payment History ................................35%
Amounts Owing and Available ..........30%
Length of Credit History ....................15%
Inquiries............................................. 10%
Type of Credit ....................................10%

Payment History

This is very simple. It looks at how you are paying and have paid your bills. If you have been 30 days late, you will be docked points. If you have been 60 days late, you will be docked more points. The later your payments are made, the more points are going to be deducted.

If you have an account “charged off” or “charged to profit and loss,” even more points are deducted. If an account has been “charged off”, it doesn’t mean the bill is no longer owed. It is an accounting term that means the account has been transferred from the active system to an inactive status and charged against the companies earnings.

An unpaid collection deducts points. A collection with a large balance will deduct more than a collection with a small balance. A paid collection also deducts points, but less points are deducted each month after it is paid. For example, an unpaid collection may deduct about 27 points, whereas a collection paid a year ago may only deduct 13 points.

Bankruptcies and paid judgments have fewer points deducted as each month passes. Bankruptcies are on the report for 10 years; all other credit is reported for seven years. The Fair Credit Reporting Act allows exemptions for judgments and large accounts, but since each state has different statutes of limitations, the credit bureaus generally adhere to the 10- and seven-year limits.

Amount Owing and Available Credit

This is a little more complicated. It looks at the various types of credit—secured and unsecured installment loans, credit cards, mortgages, collections, judgments and other public records—and the amounts owed. The lack of a variety of types of credit may deduct points.

The ratio of balance to the credit line or limits are calculated. Scoring looks at each individual trade and the limits available, then it calculates the total balance of all types of credit and the total available credit on all accounts. The closer the balance on your revolving credit is to your line of credit, the more points are deducted. If all of your credit cards are maxed out or near your credit limits, you get hit multiple times—once for being near your limit on each account and again for being near your total limits on all available credit.

Length of Credit History

There is not much you can do about this. If you are 20 years old and have credit for one year, you will just have to wait. As time goes by, fewer points will be deducted. This is also why it is not always a good idea to cancel your old credit cards, as it may end up negatively affecting your score.

Inquiries

Inquiries for credit are counted against your score, with several exceptions. Multiple inquiries for mortgage loans in the last 30 days are counted as one inquiry. Multiple inquiries more than 30 days old, but within a 14-day period are counted as one. The same formula applies to auto loan inquiries.

Each inquiry will generally deduct 1.5 to three points. If the consumer has a large number of trade lines, owes more money and has a long history, each inquiry will deduct less than a person with little credit and a short credit history. Inquiries for employment and inquiries initiated by the consumer with each credit bureau or from www.annualcreditreport.com do not count against the score.

Types of Credit

Trade lines from banks, finance companies, utilities, travel cards and credit cards are all scored differently.

What Can You Do?

First, you can get three free credit reports each year, one from each bureau: Experian, TransUnion and Equifax. Your credit report is free. If you are asked for a credit card, you have not gone to the correct web page. You don’t need to order a credit score. The credit score the credit bureaus will try to sell you, except for Beacon from Equifax, are not the same ones the banks use! In some cases the scores are not even close to Fair Isaac.

If you get only one credit report, get an Experian report. Experian is used by more banks and credit unions in central Illinois, so you will get a better and more complete report.

Examine the report for errors or inaccuracies. If you find any, you can dispute them over the Internet. Also dispute the incorrect information with each creditor and ask them to correct each credit bureau. This way, when you check TransUnion in four months, those errors should be changed. Then four months later, check your Equifax report. This way, you are checking your credit three times a year for free.

If you have any collections or judgments, pay them off as soon as possible. Each month after these are paid, less points are deducted and your score should increase.

If you have delinquent accounts, bring them current. Do not pay them off. Remember that 35 percent of your score is determined by how you pay. If you pay off a delinquent account, for the next two years points will be deducted for the paid delinquent account. Bring the account current and pay on it, at least six months or until it is paid, if less than six months.

If you have revolving accounts or credit cards with a balance over 50 percent of the available amount, pay down the balance, transfer some of the balance to another card or contact your creditor and ask for an increase on your line of credit. If your balance is over 50 percent of your available limit and you reduce that percentage to less than 35 to 40 percent, you could increase your score by as much as 50 points.

If you try to adjust your score, don’t make the mistake of going from one extreme to another. Don’t go from too much to too little credit. Keep your balances to less than 40 percent of the available lines. If you know you are going to be late, call the creditor and ask for an extension on payment. If you are going to charge a large amount on your credit card, call and request an increase in your line. Don’t accept too many of those “15 percent off” offers to get new credit cards. And most importantly, check your credit report from one bureau every four months. IBI

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Comments

Great guide, Larry. This has got to be one of the most accessible and comprehensive guides on the credit score. I think more people ought to read through this thoroughly. There's much to learn from here. I hope you can also come up with more credit crunch tips in the future. Looking forward to it. All the best, Jeremy

A good article that provides some great guidelines for ways to improve and protect your credit rating! So many unknowns and misconceptions about what impacts your credit score and this information is very helpful it understanding the largest impacts and where to focus first on improving credit scores.  Thanks!

It's always necessary for a borrower to take care of their credit scores even though they have a good credit. There are chances that this bad credit score will just pop out immediately without you knowing it. Remember credit score are a silent killer, killers that can make you indebted for the rest of your life,  so be aware beloved borrowers.

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