Many of us remember our fathers or grandfathers commenting on the use of credit to achieve our purchases as something close to blasphemy. In decades past the prevailing attitude in middle class America was “if you can’t pay for it, you shouldn’t buy it”. In today’s complicated social and economic environment, maintaining a good credit score has become critical to home, family and the capacity to function effectively in everyday life in general. It is not just about the means to finance purchases but empowers employment opportunities, social status and financial management as well.
Exactly how the credit bureaus (Experian, Trans Union, and Equifax) actually calculate credit scores is a mystery to everyone. They each have their own proprietary formulas that seem to be beyond ordinary understanding. Although the bureaus do not disclose their formulas they are forthright in providing succinct information regarding maintaining and improving scores and information on how credit patterns affect scores. The following are a few tips on maximizing credit scores.
How credit reporting works
The consumer should understand that the bureaus only evaluate accounts that are reported to them by the consumer’s creditors. If a credit account is reported to Experian and Equifax but not Trans Union it will not be reflected in the Trans Union credit score. This is the primary reason there is frequently a considerable difference in scores between repositories (bureaus). When consumers apply for credit the creditor may rely on any of the three bureau scores or all three as with a mortgage application. It is therefore important that a score substantially lower than the other two be reconciled with the repository. Frequently the lower score is a result of credit accounts with a good payment history not being reported to the repository.
Delinquent payments on any consumer account can have a serious effect on credit scores. Delinquent is defined as more than 30 days late. Payments received by the creditor 60 days late and beyond have an even greater impact on the score. Once it is reported, a delinquent payment remains on the consumer’s credit record for seven years. However as time passes the delinquent payment will have less impact on scoring if there are no further late payments reported by the creditor.
Excessive credit card accounts, regardless of the payment record can also have a negative effect on credit scores. The bureaus do not chronicle information on salary, job stability or anything directly related to income. A consumer with more than three credit card accounts raises the red flag of potential escalation of debt even if the cards are not used. Credit history is also an important factor in scoring. Accounts with a sustained good payment record should not be cancelled. Instead, one should cancel the newer credit card accounts since they have less influence on the score.
Accounts that have a high balance owed or are approaching the credit limit have a significant impact on credit scores. Transferring a portion of the balance owed to another credit card with a zero or low balance could improve the score but the best solution is to secure a relatively low interest rate bank loan to pay off high interest rate credit card debt.
Parents want to help their siblings establish credit but care should be exercised on how this is accomplished. Cosigning an auto loan or a credit card application makes the parent just as responsible for timely payments as the person receiving the loan proceeds. If there are delinquent payments, they become an element of both parties credit record. Young adults have limited experience managing credit obligations and are often incognizant of the consequences of delinquent payments. Payments should be made to the parent who in turn remits to the creditor allowing them as the cosigner to maintain control. This procedure allows the sibling to establish a credit account but only if the creditor agrees to grant the account to the sibling as the primary borrower. Obviously this is a practical approach to cosigning a loan regardless of the cosigner’s relationship to the borrower.
Absence of credit history is a common reason for low credit scores or rejection by creditors regardless of the score. This is particularly frustrating for young people just entering the workplace and recent immigrants. Since the credit bureaus only chronicle data reported to them, the information available for reporting is limited to credit card, secured loans and consumer retail accounts. Residence rental, utility payments, insurance and similar entities do not normally report to the repositories so the consumer does not receive consideration for these accounts in establishing credit. To receive a valid or generally accepted credit score, creditors are looking for three consumer accounts with a one year minimum payment history. Credit cards are the logical place to start. Credit card companies that will issue a credit card with a small maximum limit for a fee are proliferating on the internet. A debit type credit card where the consumer is required to deposit a balance that can be charged against is another approach to establishing credit card accounts. Loans from friends or relatives with a formal written agreement in place where monthly payments can be documented through cancelled checks or bank statements for one full year are a commonly accepted by mortgage underwriters in meeting the three account minimum for credit approval.
Whereas credit scores in the 760 to 850 range are only achieved by those with years of credit history including many paid accounts establishing a record of successful credit management, with three low balance credit card accounts, an auto loan and possibly one other consumer account an individual can expect a credit score of 660 or higher as long as there is a one year payment history on all accounts and no payment blemishes. A score of 660 represents good credit and should allow access to further credit with favorable terms on home mortgages or in any other credit arena.
A summary of how to establish and maintain a good credit rating can be reduced to one basic rule “use it but don’t abuse it”.
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