09 April 2009

Credit Scores - Understanding and Improving Yours

Your USA credit rating is very important. It will decide whether or not you get approved for a loan. It will influence your interest rate. It might also influence whether you are hired at a new job, your car insurance rates, and your utility rates. Think of interest as money flushed down the toilet - avoid it as much as possible.

Different ways to obtain your credit report:

* If you recently applied for a loan, the lender/bank did a credit check on you and got a score. They must tell you, for free, what that number was. My bank mailed me a letter.

* You are entitled to a free report once every 12 months, thanks to the Fair And Accurate Credit Transitions Act of 2003. This is great for finding out your credit history and credit score. You might uncover items on your history that are wrong or not you. You might discover you are the victim of identity theft. You will receive reports from each of the "Big Three" credit reporting companies - Equifax, Experian and TransUnion.

* Bankrate.com offers an online credit score estimator. It's free and quite fast. I did it and the result matches what my bank recently told me. It's a good starting to point to see if your credit is bad, good or great.

* There are many different companies that monitor credit. To "join" one of these companies you have to pay a monthly fee and in return you receive updates on your credit report, alerts when something new has occured or your score has changed, as well as helpful financial information. Next Advisor has a wonderful online chart comparing several different companies, their costs, and benefits.

The following items affect credit scores:

* Payment history - All payments should be on time. Minimums or more than the minimum should be sent in for auto, personal and mortgage loans. Credit cards should be paid in full each month. Never, ever skip a payment - send in at least something to show good faith. Bankruptcy is bad - it'll be on your credit report for 10 years. Avoid it at all costs - try to work something out with your creditors. You can get loans after bankruptcy but the interest rates will be sky high and will eat like a cancer into your bank account.

* Amounts owed -

  • The total monthly minimum owed is compared to monthly income. This shows the lender whether you are living beyond your means (and have spending control issues or just aren't ready to be financially independent).
  • The balance is also compared to the credit limit. Lenders like a big gap between these two numbers because this leaves room for paying for unexpected bills (car repairs, home repairs, sudden health issues etc). When your credit card is new and the limit is low, try to keep under 80% of the limit and pay in full each month. When your card limits get higher, stay under 30%. Carrying a balance into the next month is okay but avoid it when you can.
* Age of your credit history - The older the better. Get started as soon as possible. A simple gas card is a good first step - it's something you will use regularly and can pay off in full each month. A seasoned credit history gives the lender a very good idea of who you are as a borrower. Some lenders will not give out loans to people with little or no credit history.

* Types of credit - Different types is good. It shows experience which lenders like. One car loan, one mortgage loan, one personal loan, one credit card = good mix. All credit cards and nothing else = bad.

* New credit:
  • This is almost like no credit history. You haven't proven yourself so you are considered a risk. It's a "fear of the unknown" that scares lenders.
  • The other kind of "new credit" is when someone with a longer history takes out new loans or gets new credit cards all of a sudden - this makes a lender nervous - why does this person all of a sudden need money?
  • Never apply for multiple loans/credit all at the same time. When the lenders see your credit report, they will see that everyone else is checking you out at the same time. What might happen is everyone will scare each other away and you will end up with nothing.

Your job history will also affect whether or not you get a loan as well as the interest rate. Don't be a job hopper. Find a good paying job and stay there. If you are new at a job, hopefully you were with your previous employer for many years. Lenders like stability. They feel it reflects good character which is less of a risk to them.

Having a well-paying job is important, too. Lenders will compare your loans to monthly income to determine your ability to stay financially healthy and repay them.

Hopefully, the above information is helpful.

How I established my credit score of 811 (which is excellent):

After 6 months at my first part-time job, I got a "secured" credit card from my bank. I did this for two reasons: I needed a credit card to get a rental car for my uncoming vacation (rental companies do not rent to people without credit cards). I also wanted to establish my credit because, one day in my distant future, I would eventually apply for a car loan and a mortgage - a credit history will be a must.

After 6 months of charging necessities only on my credit card and paying the bill in full every month, I applied for one gas card and used that card every week for fill-ups. I paid those bills in full.

After being at the same job for 12 months, I applied for one department store card and used it once a month only, just to keep it active. I paid my bill in full every month. I also closed my secured credit card account and got a regular account with a higher limit (thru the same bank).

When I moved into my first apartment, I was able to get the utilities in my name because I had a credit history already. Having utilities in my name now contributes to my future credit history. Always paid those bills in full. I want good credit and I want heat!

I applied for another department store card to pay for my refrigerator and couch only. I paid those two purchases off in three months. I did not do any decorating or fun spending because I consider money to be "tight" until all credit cards balances are zero.

When I applied for my first car loan, I paid extra each month, paying it off in 3.5 years, avoiding flusing interest money down the toilet. I also bought what I needed, not what I wanted.

The rest of my life follows that pattern. No fun spending until the credit card can be paid in full each month. Shop around for rates for car and mortgage loans. Refinance into lower rates if possible.

Update: Just applied for a 2nd mortgage to build another room onto our house. My credit score was 890. That's kick ass great!

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