12 Nov Your Good Credit | Owner Update
Raw Credit Report
Raw credit reports were discussed in the previous Owner Update, and the three national credit reporting agencies were identified by name and contact address. These agencies identify all creditors and credit history they can procure. However, the fact is that all credit grantors do not subscribe and report to all three credit reporting agencies. Furthermore, each credit reporting agency is located in a different geographic part of the United States, leading to deeper regional penetration in their chosen locale. This all means that any credit-reporting agency cannot report all credit activity for any individual. Some things show up on one report that is not evident on the other.
In order to overcome this problem, credit reporting businesses have sprung up that combine all three credit-reporting agencies into one report. Most mortgage lending institutions use these combined reports to assess an applicant’s credit. It is thus important to review and correct all three of your credit reports. And you should always ask to have a copy of the combined credit report your bank uses to assess your credit at the time of application. You have paid for the credit report as a part of your application fee and most lenders will provide the report at no additional cost.
Credit Scoring
With all the available raw credit information, it is still not enough for lenders to feel comfortable letting money go. Lenders now take advantage of a new service developed in the past five years called “credit scoring.” Credit scoring is a complex statistical model based on raw credit reports. These scoring systems yield the “FICO” score.
The FICO score is a critical determinant of how much money can be borrowed and at what interest rate. Each of the three credit reporting agencies has developed its own statistical model with its own name. The Experian FICO score is called “Fair Issac.” Equifax calls its FICO score “Beacon.” Trans Union calls its FICO program “Emerica.”
It is important for a borrower to know and understand their FICO score. Most lenders buy FICO score reports from all three agencies to compare. Top scores in the 800 range will ensure the best interest and loan terms. Most banks set a minimum score of approximately 650 or more for the best loan terms. If a borrower’s FICO score is lower the loan is considered ‘sub-prime’ and riskier, forcing higher interest rates and larger down payments. It is interesting that an individual score can range from 680 on one report to 740 on another report.
The FICO score is based on the total picture of a borrower, including payment history, the total amount of credit granted by all sources, the amount of credit used, the ratio of credit debt to income, and many other factors. Recent publicity has forced FICO scoring into the public eye with federal legislative proposals that would force credit-scoring companies to open their models to public scrutiny. FICO scoring has proved to be a reliable creditworthiness gauge and will not go away anytime soon.
It is important for anyone planning to obtain institutional financing to know and understand his or her FICO credit score.
The FICO credit score is based mainly on current credit use and past credit payment history. In this regard, having many credit cards with open credit is not always good. The FICO score can see the unused credit as a potential risk factor if suddenly used, causing monthly payments to increase. Additionally, late payments and missed payments can create a history of irresponsible credit use, causing the FICO score to be reduced. FICO scores change daily as, just as your credit report changes based on the amount of credit used in any particular month.
Credit Cards for Fun and Profit
In this day and age credit cards are the rule of the day. They permit quick payment of most transactions with excellent record verification of expenditures. Credit card used for business expenses is an outstanding way to maintain a concise record of tax deductions. Credit card use should be meticulously planned to meet personal needs and enhance credit reporting agency FICO ratings.
First and foremost, credit cards should be used and paid each month to avoid any interest payments. Interest should never be paid on credit card debt. It is very expensive, with interest rates ranging as high as 24%, and these costs are not tax deductible. If current credit cards have balances, they should be paid off as soon as possible, and no further balances are ever carried again. If the cardholder can control his/her charging habits, using savings to pay off card balances would be worthwhile. This has the effect of paying oneself 24% interest (by saving payments) versus the 6% interest earned on savings. However, if new balances are immediately spent again, nothing is gained.
Another strategy many people use to pay off high-interest credit card balances is obtaining a home equity loan. For most people, home interest is tax deductible. By paying off credit card balances with home equity loan proceeds, the cardholder usually reduces interest from 24% to 9% and obtains a tax deduction benefit. However, this plan has no benefit if the cardholder runs up new credit card balances.
The bottom line is simple; credit card holders must stop spending money they don’t have. And they must not make credit charges until they know they can pay them when the next bill arrives. This gives the cardholder the privilege of a free thirty-day money float at the expense of the credit card issuer and the pleasure of what is, in effect, an interest-free loan.
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