|
PERSONAL FINANCE
Secrets to keeping your credit score high
BY JENNIFER WATERS
MARKETWATCH
A happy consequence of this Great
Recession is that Americans are widely expected to be better consumers.
That means we'll only take on loans
that we can afford, pay off credit-card debt at the end of each month
and sock money away. It also means our credit scores will reach what the
industry calls super prime, the top score achievable.
Or will they? Turns out our scores
are not just a reflection of our ability, or lack thereof, to pay on
time, but they tell a story of how we run our lives. If there's a blip
in that story, say a 30-day late payment, the red flags pop up and all
those years of paying dutifully can fall flat quickly.
Much attention has been focused on
credit scores during this recession as consumers have struggled to keep
up with their mortgage payments and revolving debt. Many consumers --
even those who have long had outstanding credit ratings -- have
complained that their scores have fallen as credit-card companies
slashed limits and closed inactive cards.
Still, people shouldn't worry so much
about their scores, according to experts. ``It's less about the score
than it is about the information that's contained in the report,'' says
Steve Katz, senior director of consumer education for TransUnion. ``The
score is only a reflection of what's in the report.''
The most important information in
your credit report is your bill-paying history. It bears repeating: Pay
your bills on time every month. A whopping 35 percent of your FICO
credit score is tied to that payment history.
Another 30 percent of your score is
based on your outstanding debt. Lenders expect you to use credit cards
but to do so prudently. If you have three credit cards with a total of
$30,000 in available credit, they will look at how much of that you're
using. That's your utilization rate. Don't max the cards out. Don't even
come close.
Figuring out your utilization rate is
easy math. Add up all your outstanding balances and divide by your total
credit limit, which should produce a number less than 1. If it hits 1,
you're maxed out.
CREDIT LIMIT
Most credit experts, including the credit bureaus, will advise you to
keep your credit utilization under 30 percent of the total limit.
But here's a secret: Make sure you do
it for each card. If you exceed that threshold on one card -- say you
use 70 percent of that limit but only 10 percent on another card and
nothing on a third card -- you're under 30 percent of the total limit.
But you'll still get dinged for using so much of the limit on one card.
How much of your limit you use in any
given month can turn the tide on your card. If, for example, you max out
your American Express card every month but pay it in full, you can still
get slammed for hitting your limit. The credit card companies don't
report if you've paid off your card, only how much you spent.
"Whether you pay in full or not is
not relevant,'' says Maxine Sweet, vice president of public education at
Experian. "If I charge $5,000 this month, the credit history is not
going to know if that $5,000 is part of a longer-term bill or not. From
a scoring standpoint, what's important is: How does my balance of $5,000
compare to my total credit limit?''
About 15 percent of your score is
based on your credit history, which doesn't bode well for college grads
just getting on the bandwagon. But if you've been managing your credit
well for decades or more, chances are your numbers are high.
But remember this: The higher you
climb, the farther and faster you fall. If you've been doing a stellar
job of managing your credit for 20 or 30 years and one month you miss a
payment -- say, you landed in the hospital with a bad leg break -- not
only do the red flags go up but the warning sirens go off at full blast.
You automatically get put into a much riskier credit category than the
neighbor who tends to be a bit late on his monthly payments.
Seems unfair, you say? It's because
you're exhibiting uncharacteristic behavior. The system reads that as
something is wrong, so wrong that you now might not be able to pay your
car loan and the department-store credit card on time.
Craig Watts, public affairs director
at FICO, which produces credit scores, described it metaphorically as
this: You're the perfect angel of a child during all of grade school and
junior high, but then you get to high school and discover partying is
not the bad thing your parents said it was. You become so good at it
that your angelic history is now mud.
``Your reputation is suddenly skewed
heavily to the left,'' Watts says. ``It will take time to restore that
pristine reputation. The same thing happens with credit risk and credit
score.''
The lesson here: Your credit score is
your credit reputation.
IMPORTANT RATIO
Here's another thing you probably didn't know: Many banks rely on a
statistic known as the odds-to-score ratio that has more to do with
people like you than you alone. It tells lenders what the likelihood is
of a 90-day delinquency based on what your score is.
For example, a FICO score of 780 tells a lender that for all the
consumers in his marketplace with a score of 780, one out of every 400
will become 90 days late in the next two years, meaning your
odds-to-score ratio is 400-to-1. The ratios fall in tandem with the
scores.
Your credit scores are also affected,
though less so, by your pursuit of new credit. And they are a catch-all
of your history.
``Everything in your credit history
will have an impact,'' Sweet says. ``A credit score will have many
factors and considers every element in the credit history.''
When you actively seek new or more
credit, your rating gets what's called a ``hard inquiry'' that pares a
few points off your score. When the banks check your credit -- most of
them do it every 30 days -- that's considered a ``soft inquiry'' and
won't affect your rating. Same is true for mailers with pre-approved
credit lines.
``Don't apply for too much credit in
a short period of time,'' Katz says. ``You start to look credit-hungry
and each one of those applications triggers an inquiry. Three or four in
a short period of time start to add up.''
The type of history you have also
shows up in your scores. Banks typically like to see that you have a
good track record with revolving credit and installment loans.
``A good mix of credit can be useful
to your score, but not so useful that you should open a credit card to
get it,'' Watts says.
KNOW THE SCORE
Finally, should you be checking your credit score regularly? It depends.
There are services you can sign up for that will track even the tiniest
of changes to your score, for a fee.
TransUnion's Katz says you should
know what your score is at all times. ``Your accounts are being updated
by your creditors every 30 days,'' he says. ``You should know what they
contain because it can change.''
But Experian's Sweet, who has a
regular check on her score, says don't be obsessive about it.
``People are chasing their score too
much,'' she says. Consumers should spend more time understanding how
their credit actions affect their scores. ``You have to be educated
enough to know what is in your credit report and how it is scored.''
FICO's Watts says you should simply
be financially fit. ``Rather than micro-manage your FICO score, it's way
easier to adopt careful management habits,'' he says. ``If you do that
and your score is high, like the upper 700s, you don't have to worry
about dings if you close an account and open another one. Who cares?
Don't worry about the little stuff.''
Don't forget the good news: Credit
scores are salvageable.
``The worse the situation, the longer
it's going to be to recover. A bankruptcy or foreclosure will take
several years to fix. But the nice thing is your score can recover,''
Watts says. ``Bankers have come to respect the fact that people do learn
new rules, and that many can go through difficult times and become good
borrowers again.''
Read more
in the Miami Herald
|
