Credit Score Conundrums

In my previous post, What are the Components of a FICO Score?, I discussed what the Fair Isaac Corporation takes into account, and each items respective weight, when calculating your FICO score. The interesting thing that I have noticed is that certain practices can both raise and lower your credit score. Lets look at a few of them:

(1) 30% of your score is based upon you debt to credit ratio, while 10% of your score is based upon the number of credit inquiries and “new” credit. The ideal situation is having a maximum of 25% of your credit in use as compared to your debt. Therefore, if you have $1000 in credit, you want to owe no more than $250 total.

As you continue to make consistent payments on your cards, you will most likely become eligible for a credit limit increase. However, you usually have to ask the credit granting company for an increase on your limit. This is good because it will lower your debt to credit ratio, however, you have just created “new” credit and just had an inquiry dinged against your credit report, and thus could lower your score. Interesting!

(2) Some experts state that you should pay off your outstanding balance in full while other experts say that creditors want to see consistent payments, thus you should always pay your bill over time. We now know that 35% of your FICO score depends upon timely payments. Nowhere in that calculation does the amount paid come into affect. Creditors send you a bill with the minimum payment set for you. Most experts agree that you should more than the minimum payment, but not for credit score reasons. You should make more than minimum payments so that you do not get hosed by the interest charges.

The bottom line is, paying off your amount due, whether in full or in parts, is not going to hurt your score (as long as those payments are timely). If you can afford to pay more than the minimum payment, do it. If you cannot, do not. I seriously doubt a creditor is going to penalize you (by means of a lower credit score) for paying back their money in one lump sum!

(3) 10% of your score is based on the type of credit you have. Most people build their credit score in order to take out installment loans, however, installment loans can lower your score. The situation that presents itself is an odd one. Most people build their credit score in order to purchase a car and/or home. However, taking out one of these loans can lower your score because some creditors may feel that this big monthly obligation could affect your ability to pay them back. Now we are back to the debt to credit ratio and the choice of whether or not to raise the credit limits.

The truth is, it seems that certain simple strategies (pay your bills on time, keep your debt low, and keep your credit high) have been to proven to build a credit score significantly. All of the other little things can either slightly chip away or slightly add to your credit score. As I pointed out, some strategies can have both a positive and negative effect. Therefore, if you want to play it safe, stick to the simple strategies and always be aware of the contents of your credit report and credit score.

Should You Obtain the Services of a Credit Monitoring Service?

As I have been discussing in previous posts, credit is a very important asset in today’s society. Differing views exist as to the overall importance of credit versus the importance of cash, however, supporters of the latter do not deny that credit can be a useful tool.

If you have credit, do you know how to protect it? As you may know, identity theft is one of the most “popular” (for lack of a better term) crimes to commit. Two problems exist with credit and identity theft. First, victims of identity theft have a hard time repairing their credit even though the victim is not the guilty party. Second, you are not aware you are a victim of identity theft until you try to make a purchase that requires a credit inquiry.

Many identity thieves use a different address when obtaining credit in the victim’s name. Therefore, the victim receives no bills, no late notices, and no phone calls about defaults and delinquencies. In the normal, everyday use of your credit card, you credit report is not inquired upon to see if you qualify for a purchase. Your credit report is only used if you intend to make a large purchase (such as a house or automobile). This can leave you “in the dark” as to any illicit credit activity for several months. In the meantime, your credit is literally being destroyed!

In order to prevent this, I use a credit monitoring service. The credit granting company I use offers such a service for $12.00 per month. It has every feature you can think of and gives me instant access to my full credit report and all three of my credit scores. I use this service because it will enable me to quickly identify any unusual information on my report, as well as show me if my credit score raising techniques are working. In addition to those services, the credit monitoring service also notifies me if any unusual activity is being reported on my report.

If you choose to obtain these services, make sure you follow some guidelines:

(1) Make sure the company is reputable. You are going to be giving this company all the information (including your social security number, your address, your birthday, etc.) it would every need to steal your identity. Make sure that the company has many safety features to prevent that from happening.

(2) A larger price per month does not mean better service or product. I have seen prices from $12.00 per month to over $100.00 per month for these services. Make sure you are getting some vastly superior product or service if you choose to shell out an addition $88.00+ per month.

(3) Make sure the service is easy to use and has a way to be immediately reached in the event that you notice suspicious charges on your credit report. You do not want to find something wrong and then find out that you have to submit a claim that could take weeks to process!

If you decide that these services are right for you, shop around, and find the best deal. Protect your credit now and you will be able to save yourself some frustration in the future. Think of this service as a necessary insurance in an identity theft rich time.

What are the Components of a FICO Score?

The Fair Isaac Corporation is the company the created the FICO score for credit. A credit score can range between 300-850. All three of the credit reporting bureaus (TransUnion, Equifax, and Experian) use a FICO score system, except each bureau calls their respective systems by a different name. TransUnion has EMPIRICA, Experian has the Experian/Fair Isaac Risk Model, and Equifax has BEACON. Do not be confused by these names. Although different by name, these credit bureaus’ systems differ only slightly in calculation.

Although the exact formula used to calculate a FICO score is unknown to the general public, the Fair Isaac Corporation has released the components used to calculate a score and their respective weight in the calculation.

35% of your score is based upon your Payment History. Late payments of all types are reported in your credit report. People are sometimes under the misconception that as long as they pay their credit cards on time, it does not matter if anything else (like your car payment, your cell phone, doctor bills, etc.) is late. This is far from true. Any late payment to a creditor can be reported in your credit report by way of collections, lawsuit, wage garnishment, attachments, lien, and judgments, to name a few.

30% of your score is based upon your Amounts Owed. This is called a debt to available credit ratio. Basically, if you have two credit cards with a $2,500 limit on each, your total available credit is $5,000. If these accounts are “maxed out” then this will lower your score. As a good rule of thumb, you generally want to have a total of only 30% of your total credit in use. Therefore, in this example, if you owe $1,500, you should be okay. Anything more, and you may be at risk of lowering your score.

15% of your score is based upon the Length of Your Credit History. This makes sense if you think about it. If you just got a credit card, there is no accurate way to gauge your creditworthiness. The longer you have credit, the more accurately lenders can determine the risk of lending you money. This equates into a higher score for you.

10% of your score is based upon New Credit. This does not mean that you should not open up any new credit cards. If you want more credit, do so sparingly. If you try to open and/or apply for a lot of credit at one time, it looks like you are in financial trouble or that you are going to be amassing a large amount of debt. Either way, it does not look good to lenders and can negatively affect your score.

10% of your score is based upon the Type of Credit in Use. Also referred to as a “mix,” this component looks to all the types of credit you have. Whether it is revolving, installment, mortgages, etc., a healthy mix will raise you score, although by very little. This component really only comes into play if you do not have many revolving accounts.

Need More Money? Try Cutting Your Costs!

I had a unique experience yesterday afternoon. I was talking to a friend that was having trouble paying his bills. He was wondering how he was going to make next months rent payment (he lives in Los Angeles and thus his rent is very expensive), his car payment, his student loan payments, and all his other bills. He kept wondering and asking me how to make more money.

During our long conversation, I was amazed that he was considering getting a second job (considering he already worked 60 hours a week). What amazed me further is that he never considered cutting costs. His entire motivation was about making more money.

First, let me start that making more money is a great goal. The entire purpose behind this blog is to share knowledge on how to acquire wealth. However, wealth accumulation can be a long process. Absent hitting the lottery, millions of dollars do not come overnight. It takes hard work, dedication, and motivation.

Most people in my friend’s situation think one dimensionally. The problem presented in paying bills. They think “I do not have enough money to pay bills, therefore, I need to make more money!” This way of thinking is not incorrect, but it can create many problems in the immediate future. Let us say that my friend got a second job on his days off. I guarantee in a month, he would have no energy and his primary job performance would suffer, as well as his health and personal life.

An easier way exists. I told him he needed to cut costs. Cutting costs will have an immediate effect. I told him to stop going out to eat so much (he went about three times a week), brown bag lunch at the office, and stop buying unnecessary stuff. Additionally, I told him to contact his student loan office and ask for a month reprieve. I think that most student loan providers allow the payee to request a “month off” without penalty. Taking a month off will put him a month ahead on his student loan payment.

There are many other little costs he can cut that will add up big in the long run. My biggest piece of advice for him was to NOT form a budget. Budgets are too hard and people never stick with them. All I said was to keep track of the costs that you eliminated. This way, he will be able to see a noticeable difference in his checking account, and most importantly, he may not have to pick up a second job!

Do You Know What Is In Your Credit Report?

Many Americans would be amazed as to what they find in their credit report. I have had to deal with errors in my credit report for a long time now. My problems arise because I am named after my father. You would think that in this day and age, and with the many technological advancements that exist due to computers, distinguishing between two different people would be easy. Apparently, this concept eludes the credit reporting bureaus.

Due to the fact that my father’s accounts appear on my credit report and vice versa, I constantly have to contact the three bureaus and the reporting banks. It really is a nightmare! I have to do this because two things are happening when the bureaus and the banks incorrectly report accounts in my credit report. First, I lose confidence in the credit reporting system and the bank that incorrectly reports. Second, my father loses the benefits of having his accounts in his reports and my debt to available credit ratio changes, which could lower my score.

As you may know, Congress has changed many laws regarding credit reporting in order to benefit the consumer. If you go to www.annualcreditreport.com, you will get a free copy of your credit report from all three reporting companies. These reports are 100% free, meaning you do not have to sign up for some 30-day credit monitoring service. In is important to note that you can only get one free copy of your credit report from the three bureaus only ONCE per year!

If you share your name with somebody in your family, it would be a good idea to check your credit report. Keep in mind that you will not get access to your credit scores, but you will see if any negative information appears on your credit report.