The recent meltdown in the media over subprime loan losses is no surprise to me. The financial press has never understood real estate and seemingly wants it to behave like Wall Street. But the truth is that when you make loans to applicants with very low credit scores, you are bound to experience a higher rate of loss.What's surprising to me is not that people with terrible credit scores are not paying their loan payments on time, but that anyone would allow their credit score to get that low. It turns out that there are many subprime borrowers who make plenty of income. They just don't handle it well.
Lest you fall into the subprime category for any reason, I have decided to review a list of my suggestions for improving your credit score. These ideas will benefit anyone, but will be especially helpful for those planning to borrow in the months ahead.
As we have discussed before, your credit score is a mathematical expression of the information contained in your credit report. Because you have three credit reports, each with different information, you also have three credit scores, although they are often close to each other in value.
Most lenders obtain all three, then select your middle score as representative of you. In other words, if a lender could describe the likelihood that you will pay back their money as a three-digit number, it would be your credit score. The higher your score, the better you are as a risk. The lower your score, well, the more likely you are to be a candidate for a subprime loan.
Credit scores were originally the creation of Fair, Isaac & Company (FICO). In recent years, other credit vendors have entered the field, including some of the major credit-reporting agencies themselves.
In brief, the computers which calculate your credit score examine various categories of information contained in your credit report on that particular date. Each of these categories carries an approximate weight in totaling your score. These include your payment history (35 percent), amounts currently owed (30 percent), the length of your credit history (15 percent), your most recent credit activity (10 percent), and types of credit in use (10 percent).
The computers use a scoring model to compress your information into a three-digit number, which is then reported as your credit score at that moment.
In their company literature, Fair Isaac is careful not to give away secrets which might allow you to influence your credit score through your behavior. In other words, we can't know for sure what the computer is looking for. But we can try to pick up clues as to what might hurt our chances of being approved.
Here is a summary of my suggestions to improve your score:
1. Pay your bills on time. Because your payment history accounts for more than a third of your credit score, it is imperative that you pay on time. And keep good records of payments so you can prove your payments were timely. Also, check annually to make sure creditors received payments on time. Always challenge late charges.
2. If you ever fall behind, get current as soon as you can and stay that way in the future. The Fair Isaac model weights recent activity more heavily than past problems. The most recent six months appears to be critical in the scoring process. Make sure you stay squeaky clean in the year preceding your application for any major loan.3. Check all three of your credit reports regularly for errors and identity confusion.
Remember that your credit score is composed strictly from historical data contained in your credit report, and from nothing else. If that data is wrong or belongs to someone else, your score will not be an accurate reflection of your situation.
Credit reports (not scores) are free to Georgia residents two times each year. It's best to request your report in writing. You may download a Request Form at http://money99.com/ by pressing Additional Resources and then Free Documents. And know that errors can take several months to correct -- the process is slow and painful.
4. Keep balances low on credit cards, and work toward paying off balances instead of just moving them around. Balances near the maximum limit indicate poor credit management, and will result in damage to your score. Also, owing the same amount but having fewer active accounts may actually lower your score. Don't close or open accounts in an attempt to improve your score. It may backfire.
5. Avoid "maxing out" any account at any time. The computer model thinks this means you may be in trouble. Instead, try to show a steady decline in balance owed over a period of time, even if you have to open additional accounts. Also, try to show installment balances below 80 percent of the original loan and credit card balances below 25 percent of your credit limit.6. If you are relatively new to the world of credit, take it easy. Don't go out and apply for a bunch of credit cards all at once. New accounts lower your average account age, and that hurts more when you have been managing credit for a shorter time. But do have at least one active credit card account.
7. Avoid unnecessary credit inquiries. Every time you make an application for credit, that creditor makes an inquiry to your credit history. And each inquiry lowers your score by approximately four or five points. If you have few accounts or a short history, each inquiry hurts even more. Furthermore, multiple inquiries are considered a credit danger signal, so take it easy.
Fair Isaac claims that no inquiry is reported when you request your own credit history or when a creditor makes you a "pre-approved" offer in the mail. They also claim to compensate for rate shopping by counting multiple inquiries duwing any 14-day period as a single request. So if you plan on doing any rate shopping, get it done in two weeks or less.
It is important to know that FICO scores do not consider your race, religion, gender or marital status. That would be a violation of federal law. In addition, these scores ignore your age and any information regarding your employment or income, even though your lender may consider this information. Likewise, where you live is not a factor in your FICO score.
As you might imagine, the three major credit bureaus resent having to give you a free copy of your credit history. They intend to make up for it by charging you ten or fifteen bucks for your score. Fair Isaac has put together a package deal offering three reports and three scores for $48 at http://www.myfico.com/. But you can usually get loan officers to share your scores with you after they pull them. Typically, mortgage lenders pull all three scores, then use only the middle score on the application.
By John Adams. The Georgia Real Estate Report, June 2007.
