Understanding Your Credit Score – Josh Beane – Texas Health Credit Union
Have you applied for a loan recently to find that the hot check you wrote to Papa John’s Pizza a few years back has finally caught up with you (yes, they WILL send you to collections!)? How about you’ve never missed a payment on anything but still get a higher rate than you expected? Whether you’re looking for a home, vehicle or personal loan these days, it’s no secret the interest rate your lender offers is heavily impacted by your credit score. Here’s some basic information on credit scoring as well as some tips to improve your score allowing you to pay your lender less.
A common way lenders set interest rates is called Risk-Based Pricing. With this method, rates are based entirely on the borrower’s credit score. Lenders set rates according to predetermined score ranges. For example, borrowers with credit scores over 740 may get the best rate available while those with lower scores will pay increasingly higher rates according to lender’s scoring ranges. To avoid discrimination there will be no wiggle room here, meaning if you come in with a 736 you’re SO close to getting the best rate, but alas, so far away. This is a great time for your loan officer to analyze things a bit and let you know how you can bump your score up to the next tier.
A credit score itself is considered an indication of the likelihood you’ll repay a loan. The higher the number the more likely you’ll repay successfully. Scores range from about 300 to 850 or so. Yes, I know you personally are not just a number. In coming up with a score, the man/woman/supercomputer behind the curtain will take into consideration the following factors such as payment history, amount owed on credit cards vs. credit card limits, how long accounts have been open, new inquiries and what mix of different loan products you have.
The payment history from the most recent twelve months is weighted most heavily. This means if you’re trying to get the lowest rate possible and have had some recent late payments, you’ll need to get everything current and keep it that way for at least a year. Derogatory items such as collections and late pays, etc. will show up for seven years (weighted less and less heavily as time goes on). More serious items like Judgments and Bankruptcies are reported up to ten years.
Once something is sent to collection agency it can become a real beast. Insert your favorite Medical Bill/Satellite TV/Cell Phone Company horror stories here. But, there has been some tightening up on the reins for these companies which is good for us, the consumers. Collection companies cannot keep selling and reposting collection accounts after seven years from the original delinquency date. Take a look at any of these accounts to see if this is the case. They’ll have an original posting date listed. Dispute directly with the credit bureaus to have these removed if they’re older than seven years.
One would think that if a collection account exists, then paying it off will erase it from the credit report.
This is NOT necessarily the case. Credit bureaus will list a collection as well as its status as paid or unpaid. If you have an open, unpaid, medical collection from five years ago and in good conscience pay that debt you will be rewarded with the status of that collection account being switched from unpaid to paid. While this is good, there can also be a negative impact. New collection activity creates new collection activity, which can decrease your score. So, that same collection that was old, and therefore not much of a scoring factor, would have automatically fallen off the credit report in two more years if left unpaid. This leaves you with the conundrum of paying the people you owe vs. letting time take its course. Generally, if it’s recent, you should pay the debt if possible. If it’s past the half way point to seven years paying it may extend the time it’s a scoring factor. However, certain lenders may require that you pay off collection accounts before approving new credit.
Revolving accounts make up another key portion of your credit score and can be the easiest way to give your score a quick boost. Credit cards and lines of credit are considered revolving accounts.
Unlike pay history which requires time, changes in your revolving accounts will have an immediate impact on your score. While payment history is important on all accounts, revolving accounts are also evaluated for their capacity, meaning outstanding balance versus credit limit. The credit bureaus total all revolving accounts balances and compare outstanding balances against total available credit limits. If your revolving account balances are 20% or less of their credit limits, they impact your score positively.
Balances in excess of 20% progressively decrease your credit score. Basically, the models look for you to have revolving credit but not max it out. Let’s say you have two credit cards with $5,000 limits each and your combined outstanding balance is $7,000. Your balance to limit ratio is 70%. Every percentage point you can decrease this ratio will increase your credit score roughly one point.
Credit information is generally reported to the credit bureaus on a monthly basis. Most lenders will tell you when they report. If you make a payment before the reporting date, you should see your credit score increase. I know, if you had the extra cash you wouldn’t have needed the credit card in the first place! The trick is the card doesn’t have to be paid off with cash. You can transfer the same debt over to an installment loan and accomplish the same result. How? A personal loan will work. We do these here at the Credit Union all of the time. See if your financial institution will give your one, or call me!
Better still, do you have an old ’97 Accord hanging around that you own outright? See if your lender will take it as collateral. You’ll also get a much better rate with collateral than on a personal loan. Have a boat you keep out on the lake? See if you can use that, too! It may be time to refinance your existing auto loan. Rates have gone down significantly in the last 5 years. Refinance the existing balance and add more cash on to pay off credit cards and reap the rewards you deserve!
So using the same example from the beginning, your credit score came back at 736 and you need a 740 or better to get the best rate. You did your homework and applied for your loan at least a month before you needed it to see if any adjustments needed to be made to your credit score. Taking out just a $1,000 personal loan will change the amount you owe on the revolving accounts from $7,000 (70%) to $6000 (60%) and should increase your score around 10 points. Bam! Knowledge=Power!
Texas Health Credit Union
4800 Grover Ave, Austin, TX 78756
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