7. Our View On Credit
It's not official, but it's one interpretation!
After attending several Credit Repair seminars, credit coaching, working with customers, and dealing directly with the bureaus, we have gathered much knowledge on things you can do to improve your credit.
This is our story as we see it:
The banking & finance industry some many years ago needed to find a way to continue to lend money and extend credit to consumers, while at the same time making sure they are lending to credit worthy consumers. As long as 15-20 years ago, you could simply do business based on a handshake and a smile. It was all "who you knew". If you had a good reputation, then you could get bank loans easily. Without any reputation or if you had a bad history, you were cut off and that was that. In today's world, there are discrimination laws that prevent 'favoritism' so to speak of bank lending. There needed to be a change that would help banks recognize credit worthy consumers without discrimination of race, religion, sex, age, marital status, occupation, state of residence, etc...
A company by the name of Fair Issac Company had a method of running statistics to determine common trends. The finance industry welcomed their efforts and encouraged this Company to start their research and develop a system that would rate each consumer for the bank so that the bank itself would not have to review a clients credit history and make their own determination. This would save the finance companies a lot of time, and thus saving them money. As for the consumers benefit, this system would help consumers who did not have a direct relationship with one bank to give solid proof of their credit worthiness. The Fair Isaac Company began with their research.
To start comparing consumers, they needed to a massive amount of records to start the comparisons. They went to one of the credit reporting agencies and took a million records to start comparing. The first thing they did was separate these million records into groups. The first group was everyone who never had a late payment. Another group was anyone with a 30 day late payment. Another was anyone with a 60 day late payment. They kept going and made groups of anyone with a bankruptcy or public lien, people with 90 day late payments, and a few others. When they were done sorting they had data to start working with. They started to notice some trends. This is where the real comparison started.
They found that anyone who had a 60 day late, also had a 30 day late. They found that anyone with a 90 day late had a 60 day late and a 30 day late prior to that. They saw other trends too such as some people who had 90 day late payments had high balances on all their out standing credit. They noticed that people with bankruptcies and public liens were different from those with late payments because they made the determination that they were unable to pay the bill. They noticed the differences between people who had a long history of credit and those with a shorter history of credit and the average amount of cards they had. Balances on those cards were also compared. It turned out people who had higher balances were typically the ones who were late on a payment first.
After much more comparisons, the results turned up about 10 different ways to score people based on what is on their credit report. This system, which is still used today, is called the FICO model system. FICO stands for Fair Isaac Company.
The FICO model is used to determine how likely is it for a consumer to have a 90 day late payment in the next 24 months based on their current and past credit usage, based on a comparison of credit usage of consumers throughout the USA. Since 90 day late payments are almost the worst thing you can have with a lending institution, this is why they use the FICO model to determine a potential customers credit worthiness. Almost all lenders and credit grantors look at a consumers FICO as a way of determining whether or not the consumer will be willing & able to repay the money extended to them.
A simple way to look at this is if you lent money to a friend/person and they were late in paying you back, or even worse did not pay you at all, then how likely & willing would you be to give them money again?
You might give them money a second time if they repaid you in full but were late, although this time you might make the person give you more in return, or you might lend them less money. This is exactly how the banks work. If a person is delinquent on money they received from a lender, then why would another bank want to lend out money to this person? There is record of the consumer not paying, and another bank does not want to be in the position of having to chase down their money. It is costly to them and makes the whole Endeavour of lending you money not worth it to the bank.
So, what does this mean for the consumer? Well, many things. This type of information lets you know that the banks are looking at your credit history as basis of your future actions. And we've heard the statements before too many times, "Well I'm different, I'm not like that anymore." "I have a new job, I will repay the money, just let me borrow it." "That will never happen to me." The bottom line is, if you can't repay your debts, you will either only be allowed to borrow smaller amounts of money or you will pay higher interest rates for the money you are allowed to borrow. As a consumer, you need to make sure that when you apply for a loan or credit, you know what the bank is looking at. While you will never be able to determine your own score unless you purchase it directly from the bureaus. (NOTE: not all scores you receive are the score the mortgages and finance companies receive. There are scoring models out there that use a rogue method of scoring, but not all banks use the score you purchased. They most always have a subscription to a credit agency to order reports with the score calculated directly from the bureau for their purposes. Do not be surprised if you think you score is one number and a bank pulls another. Chances are you bought a score from a non-qualified source)
To continue on, knowing banks are looking at your credit history and more importantly that credit score you are given, it should be important to you to know what makes up that score. The 56 major pieces are Payment History, Balances, Types of accounts in use, New Credit, and Length of credit history. Each person should review their credit report to check up on their accounts to ensure the information being reported is as accurate as possible. If you notice something wrong in anyone of these 5 categories, your FICO score could be lowered as a result. Fixing these errors is important to make sure the banks get the most accurate information to make a determination whether or not you get the money you applied for.
Let's go over some typical scenarios. See if you can determine WHY these are all bad and associate them with each of the 5 credit rating categories above. The answers may surprise you, but remember, if your scores are not over 720, then somewhere in the calculation you getting defeated. Learn from the example below as an eye-opener to what is really happening behind the scenes at the credit reporting agencies.:
A) You have 5 credit cards all with $1,000 limits. You have a zero balance of 4 of them because you "don't use those cards". The 5th card is the one you use all the time. It has a balance of $800 on it.
B) You have 3 credit cards with balances on them and you want to roll them into a new card with zero percent interest credit card.
C) You are planning on buying a house (or refinancing) and you want to buy a new car before you buy the house to make sure you get the car.
D) You co-signed on a loan for someone who may not be able to make the payments on-time. You noticed they missed a payment by 30 days and then made the payment. You now want to get a new car loan or mortgage.
E) You decided to close a few of you older credit cards because you don't use them anymore.
F) You want to increase you limit on a credit card so you close that card and get a new one from the same bank.
A) Category affected: BALANCES & PAYMENT HISTORY. Why: you have one account with more than 75% of the limit. This is a negative factor as far as credit scoring goes. The 4 cards with zero balances also affect you score because you can not rate "no activity". That means you potentially could go out an charge those up since you are already maxing out one card over 50%. SOLUTION: use your cards evenly. Carry a smaller balance on all cards to demonstrate you do not carry high balances and that you are able to make payments.
B) Category Affected: NEW CREDIT & LENGTH OF CREDIT & BALANCES. Why: you recently open a new account to consolidate those 3 cards so that adds a new account into the mix. Based on the number of cards opened (not currently open, but total ever opened since your oldest currently open account) you now have a different percentage. i.e. 3 cards of the past 5 years is fine, but if you have 4 cards over the past 5 years and 2 of them are in the past 12 months, it seems as if you are taking out too many credit lines. You also now have a card that seems maxed out. SOLUTION: Try to ask the credit card companies to lower your interest rate based on the credit score you have and the payment history you have with them.
C) Category Affected: NEW CREDIT & LENGTH OF CREDIT & BALANCES. Why: you recently open a new installment account to buy the car, this also adds a new account into equation of number of accounts compared to average age of accounts. You also now have a loan that is at it's highest amount. The ability to pay this loan and a mortgage are not determined so your score could be lowered. SOLUTION: Wait until after the home purchase or refinance before purchasing a car. The home purchase is more significant in the credit world, so more factors will hurt your chances as opposed to using a car. Most home owners will typically be able to buy a car since they already own a piece of property. This demonstrates you are a very credit worthy person to a car lender.
D) Category Affected: NEW CREDIT & LENGTH OF CREDIT & PAYMENT HISTORY. Why: You opened a new account, you have one more trade line to calculate into the equation which lowers your overall average. The loan has a late payment on it with your social security attached to it. There is no such thing as a co-borrower who is not responsible for co-signed account. That is what "co-signer" means, you are "equally" responsible for the debt, not just one person. If were just up to the one persons credit history, they wouldn't need you to co-sign. Co-signing and not paying on time is like saying you'll put you name on just about anything but you are not willing to pay the bill. SOLUTION: Do not co-sign unless you are absolutely sure you are able to watch over the payments and make sure they get paid on time.
E) Category Affected: LENGTH OF CREDIT Why: when the average is taken from you oldest open account to you newest opened account, the time frame is less, therefore your average is less, and you score is reduced. SOLUTION: Keep older cards open & active if you can. . See if the bank has more attractive terms for that card based on your credit score.
F) Category Affected: LENGTH OF CREDIT & NEW CREDIT Why: You are closing an account with good history on it and replacing it with a new account with no history on it. When the average is taken from you oldest open account to you newest opened account, the time frame is less, therefore your average is less, and you score is reduced. Also, your report shows you opened another credit account affecting how many new or recent accounts you've had. SOLUTION: Ask the bank to increase your limit on that same card number. Tell them you do not want to get a new card. If they do not offer that, then either bear with it, but make sure you do not need large credit amounts in the near future.
There is still so much more to tell, and we plan to keep updating this site with more resources for you. But we hope that you at least get the general knowledge you need to improve your credit habits and continue towards a better credit future.
Disclaimer: This is our interpretation of the entire credit reporting industry from Lender, to reporting agency to consumer. We offer this as our opinion. Facts and figures in this article are estimates as we are not responsible for inaccurate or changed information as time goes on. This information is provided to give an understanding of the concept for credit reporting, the impact it has on obtaining credit lines from banks and the importance of sustaining a healthy credit lifestyle.