The Credit Challenge

There seems to be a cloud of mystery surrounding how credit scores work, and how you can boost your credit score as quickly as possible. There are many opinions available, but unfortunately, many are just not true. So, what is the most important factor in your credit score anyway?

Payment history is the most important part of a credit score.

According to myFico.com, “payment history” within you credit score includes:

• Account payment information on specific types of accounts (credit cards, retail accounts, installment loans, finance company accounts, mortgage, etc.)
• Presence of adverse public records (bankruptcy, judgments, suits, liens, wage attachments, etc.), collection items, and/or delinquency (past due items)
• Severity of delinquency (how long past due)
• Amount past due on delinquent accounts or collection items
• Time since (recency of) past due items (delinquency), adverse public records (if any), or collection items (if any)
• Number of past due items on file
• Number of accounts paid as agreed

Most delinquencies on your credit aren’t reported to the credit bureaus until after they are 30 days late. This allows for a small grace period - which is supremely helpful to folks who aren’t adept at organization. Since you have this grace period, your credit score will not be damaged simply for being a few days late.

What’s valuable to know is that delinquencies which occurred within the past 2 years are of greater weight than older items. That means that if you see an item sent to collections, it might actually hurt you to pay it off during the loan process if it’s more than two years old.

Why? Because paying collections will decrease the credit score due to the date of last activity becoming recent. But if you do decide to pay off a collection, MAKE SURE that the creditor gives you a letter of deletion first.

If, however, you have any recent accounts with past-due amounts, paying them off immediately will help your credit score. Again, if you do decide to pay off a collection, MAKE SURE that the creditor gives you a letter of deletion first.

In credit repair, it is important not only to take notice of what you owe, but also the last active date of your accounts. Knowing this simple thing can keep you from causing your credit to bomb for paying off a collection account.

Many people are on the constant hunt to have a great credit score, or even improve the credit score that they have. Although this is a worthy cause, it is important to start your journey of obtaining excellent credit by understanding the way credit really works.

Once you are familiar with the way the credit report system works, you would be better equipped in how to dramatically increase your score, as well as maintain the high score you have managed to obtain.

So, what is the credit report system and how does it work. Great questions, and I am about to tell you just that.

First of all, your credit score is a number that represents your credit risk based on a number of different factors. These credit scores range from 300 to 850, and the national average is right around 675. The reason this number is so important is because it is a gauge that lending institutions use to determine the likelihood of you paying your debt in a timely fashion.

To get a little more specific, the score that you are given is based on the last 24 months of credit history, and using those historical facts, the credit report system determines the likeliness of you paying your account 30 days past due within the next 90 days. That sounds confusing, but it is really quite simple.

Here’s an example. If you are late on your payment this month, but haven’t been late over the last 24 months, your score will be impacted because the chances of someone having a late payment within the next 90 days is greater than someone who has never been late. However, the impact is far less than someone else who has been late several times within the last 24 months.

You can imagine that the higher your credit score, the lower credit risk you are and the more likely you are to be given credit at low rates. That is absolutely true.

Also, credit scores in the low 600s and below will often have problems obtaining credit, while scores of 720 and above will usually give you access to the best interest rates available. I like to say that once you reach a 720, you are like Noah, where the seas parted before him. Well, lenders will start parting for you!

So let’s also talk about how these credit bureaus arrive at your score. There are three main credit bureaus, Equifax, Transunion, and Experian, and each of them use different methods to arrive at your score.

Most credit bureaus use the FICO system, which comes from its developer Fair Isaac Corporation Company. This is by far the most used software since the Fair Isaac Corporation developed the credit score model used by many in the financial industry and is still considered one of the leaders in the field.

Using the FICO system, the credit bureaus and lenders are quickly able to see patterns in your credit, and then the system will provide them a score based on the finding.

Credit reports are compiled by the credit bureaus, which ultimately use the information from lending institutions and other agencies that provide your credit information to the bureaus. The type of information that is collected and factored into your score include the balance on your accounts, how many accounts you carry, the length of time that you have had established credit, the mixture of credit types, late payments, and credit inquiries.

As you can see, there are many factors that are included to determine your credit scores. There are also some important things to take note of. Your age, sex, and income do not count towards your credit score.

One can never know exactly how the credit scoring model works, however, the more information that you consume regarding credit, the easier it becomes to maintain excellent credit. Knowing this information is critical in not only establishing and managing your credit, but also repairing it.

Recently, I was on a forum pertaining to credit and I came across someone who had their credit score dramatically decrease.  Can you believe that his score dropped 100 points in about a months time?

Like many people, he was trying to pay off his derogatory accounts in preparation to buy his home, and he wanted to do everything possible to increase his credit score.  He went ahead and paid off his old accounts, and then wondered why his score dropped.  Well, here’s what I told him, and I hope that you use this advice yourself:

“The reason that your credit score dropped can quite possibly be because of your car loan being paid off early or the target account reporting while you have a maxed out balance, but those aren’t the biggest factors.

The biggest factor is that when paying old derogatory accounts, you always, always always have to be conscious of the last time they reported to your credit report.

Here’s an example. Suppose you have a collection that was from 3 years ago. You definitely owe on it, however, since it reported two years ago or more, it doesn’t do anything for your credit score to have it there, neither good nor bad.

So, in an effort to get it off your credit, you contact them and pay them off. OOPS, you now have new recent activity on your credit from these derogatory accounts that weren’t hurting your score anymore, and your score drops, because it is very recent.

So, where your credit score was rated without that collection, now immediately it is rated with this old collection that is now current.”

So, in reflection to that answer, the main thing is that it isn’t always a good idea to just go ahead an pay accounts off.  Your credit score may in fact go down.  I hope you can see the importance of seeing when the last activity date is on your credit accounts, because it can give you huge consequences!

There are many people that tell us that pulling your credit and having credit inquiries will always damage your credit score.  Well, I want to shine some light on the subject, because that is not always true.

Before we can debunk the credit inquiry myth, it is important to know that there are two types of credit inquiries.  Although this system for inquiries isn’t new, many people don’t want to talk about it because of two reasons: 1. they just don’t know better, or 2. they want to keep this information from you in order for their scare tactic to work on you (which I will get into on another post).

So, let’s get right into it. 

The first type of credit inquiry is a soft credit inquiry, or soft pull, because you are the one requesting your own credit.  When you request your own credit, there is absolutely no damage to your credit or credit score whatsoever.  The reason is simple.  How can you properly monitor your credit if you get penalized every time you access it? (You are monitoring your credit, aren’t you?)

So, you can actually access your credit every month to check for errors or new account history or whatever, and your credit score will not decrease. 

There, the secret is out!  But before you get too excited about this, I also have to mention to you that lending institutions, whether you are applying for a mortgage, a car loan, or a credit card, will not use your credit report for your safety and theirs.  It all comes down to accountability. 

If I brought in my own credit report to you, and asked you to lend me $200,000 for a house, and you didn’t check my references, but solely went off of what I provided you, would you lend me the money?  Chances are, you wouldn’t.  Well, believe it or not, there are still people out in this world that forge documents to get what they want. 

On the other hand, when the bank pulls your credit, their name, account number, and contact information appears on your report, so they know for certain that the information that they have is real.  But, more importantly, if they falsify anything just to get your loan through, they get the lawyers after them, not you.  Don’t worry though, this doesn’t happen too often, but you should know about it anyway.

The other part of soft inquiries is when you get a pre-approved offer from credit cards in the mail.  They have in fact taken a look at your credit, however, since you didn’t request it of them, it doesn’t damage your credit either. It is only when you solicit a loan that requires a credit report to be pulled that you may see your credit score decrease.  As a matter of fact, when you access your own report, these “soft” inquiries from companies will all be listed out for you, so you can see who has accessed your information.

That brings us to the second type of credit inquiry, which is the hard inquiries.  I’ve already touched on these, but let me get a little deeper into them.  These are the inquiries that you get from applying for credit cards, insurance, school loans, mortgages, auto loans, installment loans (like furniture), and other types of credit.

Since this is for commercial use, and you are looking to obtain credit with these companies, these are the damaging ones.   Now, if you have only pulled your credit once or twice in 6 months, you have no worries.  However, if you apply for 2 or 3 credit cards a month, your score can potentially drop even 80 points in a short period of time.  Be careful and smart about applying for credit.  If possible, spread them out over time, but only if you really need them (which many times you don’t).

Finally, there are two last points that I want to make in regards to hard inquiries.  If you get crazy on the credit applications, there comes a point where the credit score will stop going down, because the maximum damage has already been done.  So, let’s say that you pull your credit a million times in 5 days, that wouldn’t do more damage than pulling it 100 times in 5 days, because you’ve already exhausted all the damage that can be done with credit inquiries. There are other factors that can lower your score, but in that case, additional credit inquiries will not.

In addition to that fact, mortgage and auto loans operate a little differently as well.  For these two, you have a 14 day window which you can shop around for a mortgage or car loan without any further damage.  So, if you are shopping for a mortgage, you have 14 days to look around and multiple companies can access your credit without any damage to your score.  The same goes with an auto loan.  You just can’t flip flop, and apply for a mortgage and within 14 days apply for a car thinking that you will not get penalized, because that would be 2 inquiries since car loans and home loans are different kinds.

Hope this was helpful, and stay tuned so that you can find out more about the inquiry scare tactics that a lot of lenders use.