Credit Score Education

 One day grandma needed to refinance her mortgage on her home  because her rate was about to go adjustable and her payment was set  to increase. Her loan officer at the bank pulled her credit report and her  scores came in at a low 600. Grandmas credit scores had dropped by  over 200 points! The loan officer looked through the credit report for  some reason that the scores would have dropped so much. There had  to have been a late payment, collection, public record or something  derogatory. Grandma tried to think to herself, "had I let something go?".  Neither one of them could find any reason that the scores would have  dropped. There were no late payments or collections. There were no  public records or past due balances. The credit scores just seemed to  drop over 200 points for no reason. Grandma had no idea why this had  happened to her, but even worse was that she had no idea how to fix  it. Would she be able to afford her new monthly payments or would she  have to let the house go like so many other people have before her?

Luckily I was able to review a copy of her credit report and I located the  problem almost immediately. I gave her some simple advise that she  used to get her scores back up into the 800 range so she could do what  she needed to do.

This article is a crash course on the credit scoring system. Learning this information will allow you to avoid making the mistakes that my friends grandmother made. Not only will you be able to avoid making mistakes, you will be able to take control of your credit scores. You will know how to maximize your credit score before you make important credit applications. You will know the secrets of adding 50-70+ points to your credit score within weeks. Learn this information and share it with all of your friends, family and loved ones. Do not let your grandmother do what my friends grandma did. Don't let anybody you love flush there credit scores down the drain just because they didn't know any better.


Has anybody ever told you about how the credit scoring system works? Everybody has a credit score. Everybody is judged based on their credit score. Did you ever learn about credit scores in school? Did they offer a class? Did your parents teach you about credit scores?

Hopefully you can say no to each of those questions, because if 

anybody ever did try to teach you about credit scores, they probably gave you bad information. There are many rumors, lies, exaggerations and myths about credit scores. It's almost impossible to get good credit score advice or education.


THE ONLY CREDIT SCORES THAT MATTER.

There are a few different credit scores out there available for you to purchase but there is only one credit score that the banks and lenders use. That score is called a FICO score. FICO has a complete monopoly 

on the credit scores that the banks use. When you make an application for a credit card, mortgage loan, car loan of anything else, they will be looking at your FICO scores. FICO has designed many different types of credit scores using different algorithms. These scores are all used to evaluate the risk potential based on the information in each one of your credit reports. The FICO scores that the banks will see are called Fair Isaac V1, Fair Isaac V2, FICO Classic 98, FICO Classic 04, FICO Classic 

08 and Beacon 5.0.

Equifax, Experian and Trans Union are the three credit reporting agencies. The produce your credit reports. FICO creates the credit scoring algorithms that analyze your credit report and spits out a credit score. You cannot access your FICO scores. Only your lender, creditor or banker can access your FICO scores. Even if you go to FICOs website and purchase a credit score from them, it will not be a Classic 04, Classic 98, Beacon 5.0, etc.


Although there are many different types of FICO scores, they all work basically the same way and the most important information that I can give you about credit scores is this:

Only OPEN and ACTIVE accounts will build your credit score. 

That line is so important I must repeat it just one more time, only the open and active accounts help build your credit score. That means if you didn't have any open and active accounts at all, you would have a 0 credit score. It doesn't matter if you had  paid off auto loans and mortgages in the past. It doesn't matter if you used to have big time credit cards with huge credit limits. Only the open and active stuff counts.

That's not to say that late payments on closed accounts won't still hurt your credit score because they absolutely do. Maybe it's kind of a double standard but I didn't create the rules. Derogatory stuff on closed accounts still hurt our credit scores. We just don't get any credit score points for the good payments that we made accounts that are closed.

 Did you know that your credit  score can actually go down  when you pay off a car loan?  How does that makes sense?  Throughout the duration of  your car loan you are building  credit with every payment that  you make. You might 

 be getting a pretty large  increase in credit score  points due to the payment  history on your car loan. When  you finally pay that car loan off  in full you would think that your  credit score would go up but  no, your credit scores will go  down. The scores will go down  because only open and active  accounts help your scores. Now  that your car IS paid off, that  account is closed. Now that  you've refinanced, that account is closed, that payment history is lost. The account is worth zero.  

 

CLOSING ACCOUNTS CAN HURT YOUR CREDIT SCORE

Remember grandma? Well her credit scores dropped because she closed out all of her credit cards. The only open and active account she had left on her credit report was the mortgage she was trying to refinance. That mortgage only had a payment history of a year and a half. According to the FICO scoring system, that one account put her at a 615. That was nothing compared to the 800+ credit scores she had based off of the 25 years of credit history that she had just closed out.


BUILDING YOUR CREDIT TEAM

Since every one of your open and active accounts contributes towards your credit score, I like to think of each open and active account as a player on your credit team. You will be able to score the most points if you have a full team of strong players. If you only have one or two players on your team, you won't be able to score too many points. You need a full team of seasoned professionals and hopefully a couple of all star players in order to score the maximum amount of points. So in order to evaluate your credit team properly, you must learn the rules of the game. 

 THE RULES OF THE GAME

35% = Payment History
35% = Balances
15% = Length of History
10% = Variety of Accounts
10% = Inquiries


Payment History of course takes  into consideration all of the  payments you may or may not  have made on time. Also such  things as collections, judgments,  repossessions, bankruptcies,  foreclosures, charge offs,  settlements, consumer credit  counseling will destroy the  payment history. The aim of  traditional credit repair is to eliminate as many if not all of those types of things from your credit report as possible but it is important to note that there is much more to maximizing your credit scores then cleaning up the payment history. 65% of your credit score has nothing to do with your ability to pay your bills on time. If you're looking to increase your credit scores, it would be a good idea to address that other 65%.


The Balances on your accounts affect 30% of your credit score. That's 255 points. That's a lot of points. Sometimes making small adjustments to the balances on your accounts can swing your credit score upwards in a huge way and very quickly. You can also waste a bunch of money by paying down your car loan and not see a single digit increase in your credit scores. I'll tell you why, it doesn't really matter what the balances are on your installment loans as long as they aren't upside down or past due (in this case upside down means you owe more money for the car than you actually borrowed). Most of this 255 points is influenced by the balances on your revolving accounts. Revolving accounts are credit cards, department store charge cards or any type of account that gives you a credit limit. You say you don't have any of those types of accounts? Well that is another issue entirely. Regardless, it is important to know that if the balance on your revolving account exceeds 50% of the credit limit, your credit scores will drop. The scores might drop by about 7-15 points for each accounts balance that exceeds 50% of the credit limit. Of course that amount will be relative to what's in your credit report. Having revolving balances that exceed 50% of the score is bad, revolving account balances less than 50% of the limit is good, revolving balances below 35% of the limit is better and revolving balances that are zero are the best.

Revolving balance above 100%  of the limit = Terrible
Revolving balance above 50% of  the limit = Bad
Revolving balance below 50% of  the limit = Good
Revolving balance below 35% of  the limit = Better
Revolving balance at zero =  Best***

 ***Having a zero balance on an  account can actually hurt your  credit score in some cases. If  you pay your balance down to  zero and stop using the  account, the account can go  inactive. The FICO scoring  system doesn't give you points  based on inactive accounts so  allowing your account to go  inactive will cause the points  from that account to disappear.  A zero balance on your revolving  accounts is great as long as you  don't allow your account to go  inactive. You must use your  accounts at least few times per  year to keep them fresh and  actively reporting new  information to your credit report.

Having a zero balance on an installment account is bad for your credit score because if your installment loan has a zero balance, that loan is done and closed. Closed accounts don't contribute toward your scores so zero balance on your installment account hurts your scores.

The Length of History on your open and active accounts affects 15% of your FICO Score. Basically, the older an open and active account is, the more points that specific account will be worth towards your credit score. On the other hand, new accounts can reduce your credit score because of their lack of history. In fact, if you were to go out and buy a new car, open a credit card or even refinance an existing loan, you will see your credit score drop when that new account shows up on your credit report. That is why your banker might advise you to avoid opening accounts while refinancing your mortgage. Did you know that the average person has at least one account that is 12 year old or older? People with 760+ credit score have at least one account that has been open and active for 19 years on average. Since the FICO score system only gives you points based on your open and active accounts, your credit score is basically as old as your oldest account. A better way to explain it is this: if your oldest open and active account is only 6 months old, your FICO score is only taking into consideration 6 months worth of credit history. It doesn't matter if you are 50 years old. If your oldest open and active account is only 6 months old, then your credit scores will reflect that. 

Another interesting note regarding the length of history on your open and active accounts: it is in your best interest to keep a hand full of credit cards open for the rest of your life. The longer they are left open, the older they get, the more points they are worth. Credit cards or revolving accounts are the only types of accounts you can keep open for as long as you want. Installment loans such as mortgages, auto loans, student loan etc. will close once they are paid off. You'll never be able to establish too much of a credit history on a car loan because those types of loans typically only last 3-6 years. Once that car is paid off, the account closes and you can say bye bye to all the credit score points that you earned while paying your car on time. Even a mortgage will be paid off or refinanced at some point. Installment loans are temporary. Once they are paid off, they're gone. It's best to establish about 5-7 revolving accounts and keep them open forever, never close them out. Maybe open a few extra just in case you don't like the terms on one of them or perhaps one of the companies backing the credit card goes out of business (all too common now day).

The Variety of Accounts affects 10% of your FICO Score. You are being judged based on your ability to show that you can responsibly manage a variety of different types of accounts as opposed to just one type of account. For example, if all you had was car loans and student loans (both of which are installment loans), the lenders will think to themselves, "Well, this person can clearly handle their installment loans in a responsible manor but what would happen if we gave them a credit card? We don't know! There is no evidence that this person can handle revolving accounts in a responsible manor at this point in time. I see risk." It is best to show that you can actively handle any type of account in a responsible way. Having a healthy variety of different types of accounts will help to maximize your FICO Score. 

So what are the different types of accounts and what is the best way to show diversity on your credit report? 

Most accounts will fall into two basic categories: Revolving accounts and Installment accounts. Revolving accounts include credit cards and department store charge cards. Installment accounts include mortgages, car loans and student loans. If you ever get the chance to review a credit report that actually contains FICO Scores, you might notice that each account has a specific coding. An Installement account is coded as a I1. A revolving account is coded as an R1. A mortgage, although it is an installment loan, is coded differently. A mortgage is coded as an M1. Your Home Equity Line of Credit might be coded as a C1 and if you're lucky enough the have a high limit credit card, that account may be coded as an O1. The more of these different types of accounts that you can add to your credit team, the more points you will capture from this section of your credit score. 

More to come soon.....