STOP Paying Extra

What Is a Credit Score?

Many people come into the office and ask what a credit score is and how it affects their world. If you have a Social Security number, then your world is affected by the credit scoring system. In a nutshell, a credit score is a numerical value that rates the level of credit risk you are to a potential creditor based on other creditors' experiences with you in the past. Over time, the credit scoring system has been refined to the point where it is a reliable gauge that allows creditors to make decisions based on the range a credit score falls into.

Historical data strongly supports the fact that a person with a higher score is more likely to pay his bills on time than a person with a lower score. The higher the score, the lower the risk for the creditor, and the better the terms for the borrower.

Who Generates the Score?

There are three different credit bureaus: Equifax, Experian, and TransUnion. Each company uses its own proprietary model to calculate its score. It is rare for all three bureaus to generate the same exact score, although it could happen, because they are all using their own unique model to generate a score. As you read this book, you will notice that we use the word "score" which, in most cases, could be interchanged with "scores" because the strategies we are teaching you generally apply to all three credit bureaus and the unique score they each generate.

In case you ever need to contact one of the bureaus, here is their contact information: Equifax: 800-685-1111 or www.Equifax.com Experian: 888-397-3742 or www.Experian.com TransUnion: 800-916-8800 or www.TransUnion.com How Is a Score Generated? In the mortgage industry, scoring models are used to generate scores that typically range from 350 to 850 points. There are some variations with other models that go a bit higher than that, but the traditional models used in the mortgage industry are as follows: Equifax: Beacon 5.0 Experian: Fair Isaac TransUnion: Classic 04 There are five major factors that go into determining your credit score. There are also 100 elements within each of those five factors, so there are a total of 500 elements that are looked at instantly, by the computer, that go into calculating your score.

The five major factors are the following: 1. Payment history: 35% of your score 2. Outstanding debt: 30% of your score 3. Length of credit history: 15% of your score 4. Mix of credit: 10% of your score 5. New credit and inquiries: 10% of your score Whether you consider it good or bad, there is a maximum point threshold per factor that limits the influence any specific credit event can have on your score.

For example, one late payment may not drop you into the 500s, and conversely, one perfect trade line may not push you into the 800s. When a score is generated, the system starts at zero and adds points based on the 500 variables related to your credit history until it arrives at a score. You must have at least 350 points to generate a score. If you don't, the system comes back with no score.

You could have a score as high as 850, although it is extremely rare to see a score that high. In fact, the highest score we have ever seen was a man in his 60 s who had a score of 846. Certainly, this gentleman had a long history of responsible credit management.

How Long Is a Score Good For?

A credit score is a snapshot in time and is only good until something on the report changes. This could be as simple as your credit card company uploading their monthly report to the bureaus. Your score could be 740 today and be higher or lower tomorrow if something was reported to the bureaus in between that time. It could also stay the same for two or three weeks because the score will not change until something new is reported.

Once new data is introduced into your report, the system makes an analysis, and an updated score is generated.

This step could easily increase your credit score by five points or more. The credit bureaus track whether you pay more than the required minimum monthly payment. This is only tracked on revolving accounts (e.g., credit cards) and not installment loans (e.g., car loans, student loans, etc.). The system tracks your minimum payment due and compares it to the payment you make.

Making your minimum monthly payment is the expectation, but paying more than the minimum is going above and beyond, and you are rewarded for it. To take advantage of this, add an extra $10 to your minimum monthly payment. If your statement tells you to pay $25 dollars, then pay $35 dollars. Do this every month, on every credit card, and watch your score increase!

This strategy has the potential to increase your credit score 10 points or more. The way information is reported on your revolving accounts (e.g., credit cards) can be used to your benefit to generate a higher score if you know how to work the system. Most credit cards accrue charges through a certain day of the month and then give you a 25-day grace period before your payment is officially due. Did you know that whether you make your payment before, on, or after the due date has a direct influence on your credit score?

Making your payment on time is the expectation, but making your payment early is going above and beyond, and you are rewarded for it. You want your payment to post to your account at least 48 hours before it is due, but paying it sooner is even better. Unlike installment loans (e.g., car loans, student loans, mortgage loans, etc.) where the creditor only reports to the bureaus "Paid as Agreed: Yes or No," revolving accounts require the creditor to report the date your payment was due and the date you made that payment. This deeper analysis allows the credit scoring system to fine-tune rewards and penalties by rewarding you for making a payment early, treating you as neutral for making it on time, or penalizing you for making it late.

Let's say your credit card statement ends on the last day of the month, and your payment is due on the 25th of the following month. If you make that payment as soon as the statement is issued, then that creditor would report to the bureau that you made your payment over three weeks BEFORE it was due. Imagine how favorably the system would view a payment made three weeks early. Do that consistently on all your revolving debts and watch your score increase!

This strategy could immediately increase your credit score by 20 points or more. Your credit card's current balance compared to its limit (also called the balance-to-limit percentage or utilization percentage) factors heavily into determining your credit score. Experience has shown that 30%, 50%, and 100% are major thresholds that directly affect your score. Let's say you have a credit card that has a limit of $1,000.

If your balance on that card is $1,050, you would have exceeded your limit and would be assessed a double penalty for going over your limit, which could literally cost you up to 100 points. If you were to bring your balance under $1,000, your credit score should increase. When you lower your balance to $499 or less (under 50% of your limit), your score should improve again. If you lower it to $299 or less (under 30% of your limit), your score should improve again.

Technically, there are additional small little "lines in the sand" between 0% and 100% utilization ratios, but the quickest and most dramatic movement in a score is seen by lowering your balance to below 30%. Ultimately, the most optimal place to be for the best score is with a balance under 10% of your card's limit. Because your credit score is a snapshot in time, small changes within a very short period can affect it, be that positively or negatively. One of the best ways to get extraordinarily quick results is to know the date your creditors report to the bureaus.

Call your creditors and request that they tell you what date of the month they regularly upload data to the bureaus. With this information in hand, you now have an "Optimal Payment Date" (a few days before they upload) and can strategically pay down specific credit cards to targeted balance-to-limit ratios (i.e., from 100% to 50% or from 50% to 30%) and see an immediate change in your score as soon as the new balance is reported. It's worth noting that getting the balance on a card with a limit of $1,000 down to $300 will have the same positive effect as getting the balance on a card with a limit of $10,000 down to $3,000. If you are wanting to move the needle as quickly as possible with the least amount of cash, be sure to focus on your cards that have the lower limits because it will likely take less cash to get them down to 30%.

Another strategy that could help if you have a revolving account with a high utilization ratio would be to spread that balance over a few cards instead of having it all heaped into one. Let's say you have a credit card with a credit limit of $10,000, and it has a balance of $9,000. The fact that the utilization rate on the card is 90% is affecting your score in a negative way. If you were to transfer $6,000 of that balance to two different cards (i.e., $3,000 to each card) and each had a limit of $10,000, then you would have three cards that each have a 30% utilization rate rather than one card at 90%.

Having three cards at 30% utilization would give you a much better score than having one card at 90%. Now, if you try to open new credit lines or new credit cards to do this, it gets a little trickier. Instead, you will want to make the transfer to existing cards because, once you start opening new trade lines, you are going to get hit with inquiries and recent credit accounts that have no history. Those risk factors will likely decrease your score and wipe out the benefit you were hoping to see by spreading out the debt in the first place.

If that is your situation, this strategy will still work. It is a long-term play, however, that will take six to twelve months to work out because it will take that long for the inquiries to start fading, and for the new credit lines to have a history that is considered positive.

This strategy could increase your score by another 5 to 10 points. To keep your revolving credit lines (e.g., credit cards) in a position where they carry the most weight and are helping your score the most, they need to be used at least once every six months. If recent activity is not happening, the long-term history of those accounts is still considered and positively affects the score. The portion of your score that comes from recent activity, however, starts to fade.

Knowing this, you will want to rotate your credit cards periodically and use them to buy a tank of gas at least every six months so that you maintain "recent" activity with all your cards.

Here are three things the three major credit bureaus don't tell you that could cost your score 10 to 50 points.

Insight #1: Closing Old, Unused, or Rarely Used Accounts Will Hurt Your Score

Over a decade ago, the prevailing thought was that unused accounts should be closed because someone who had a lot of unused, open revolving credit lines could suddenly go crazy and charge a ton of debt over night. Since then, sufficient data has been collected to prove just the opposite is true. People who have large amounts of unused revolving credit are typically responsible and do not tend to suddenly use credit foolishly. Because of that, the credit models have been adjusted over time to reward those who have large amounts of unused credit available to them.

It is now an indicator of stability and responsibility, so do not close any of your old accounts. Another reason for not closing your old accounts is that they are part of your "credit history" and contribute in a positive way to show that you have been trusted with credit for a long time. The longer your credit history, the more likely you are to have a higher score. Many people come to see us and, with great pride, declare that, in preparation for purchasing a home, they have closed all their old, unused credit accounts, along with any that have ever had late payments on them.

This is misguided thinking, and when we pull their credit, these clients quickly see the irreversible damage they have caused. Closing an account with a late payment does not make the late payment disappear. It is still there. Closing the account will only hurt you by removing it from a list of active credit lines that have a long history.

Please do not ever intentionally close any credit line unless you already have a healthy breadth and depth of credit history so that losing that line would have little to no effect. If you feel you must close accounts, then start with the newest accounts that have the least amount of history to lose. Some people are also torn about whether to close a card that is rarely used and has an annual fee. If that is your main source of credit history and you have no plans to use or need a credit score for major purchases soon, you may choose to obtain new credit lines and then cancel the card that has a fee.

You need to realize, however, that your score will likely decrease until the new cards have built up some history. The safest approach would be to get the new cards in place and let them accrue history for a year before getting rid of the card that has a fee, even if that means you must pay the fee for an extra year. If you already have a strong history with multiple accounts, then canceling that one card will likely have little effect on your score. Even though closing an insignificant card may not wipe out the rest of your stronger, longer-history credit lines, you need to consider that closing any of your revolving accounts will cause your overall debt-utilization ratio to go up.

The system looks at total credit available to you on all your combined credit sources and compares it to the amount you are using (i.e., total amount in use divided by total amount available). A lower percentage of utilization results in a higher credit score. You can easily see that closing all but one card, your favorite card that you use all the time, would lower the total available credit and increase the percentage of available credit in use, which would result in a lower score. Again, don't close any credit account on a whim without thorough consideration.

Insight #2: Discount-at-the-Register Credit Cards Could Cost You

You need to know that third-party finance cards, like department store credit cards and finance companies, are considered low-quality credit because they are easy to qualify for and few people ever get turned down. We are sure you have seen this scenario because it happens all the time. For example, you're in a store like JC Penney or Home Depot, and they encourage you to apply for a credit card on the spot in exchange for a 10% discount on your purchase. Think it through before you do it because that's considered third-party financing.

Depending on your overall risk rating, a new finance company credit account could hurt your score. If you already have a lower score or are in the rebuilding stage of your credit, you may not be as concerned. At this point, your focus is getting someone to give you a chance so you can prove yourself and start to move your score in the right direction. On the other hand, if you already have a higher score, a new finance company credit account may lower your score.

The fact that you are turning to a lower-quality card is likely to be interpreted by the system that you are unable to secure credit from the higher-quality sources you have in the past. It may be an indication that something has changed, and caution is warranted. Think about it: why would you accept a new card with less-favorable terms than you are accustomed to getting from the bank you have always worked with? It could be that something happened, and now the A-grade credit options are no longer available to you, so you must settle for B-grade or C-grade options.

Remember, a higher-quality card that is more difficult to qualify for will always carry more weight in the scoring system. There was a time when some of these lower-quality credit card options played a dirty trick to keep their card holders' scores on the lower end so they would be less likely to leave them for higher quality cards. They purposely omitted the credit limit in their monthly reporting to the bureaus. As previously mentioned in Strategy #3, a person's score is affected by the percentage of a credit card's limit that is in use (i.e., the balance divided by the limit), and the higher the ratio, the lower the score.

When a credit limit is not reported by a creditor, the bureaus automatically assume that the limit is the balance, which then reflects 100% usage and results in a lower credit score. By omitting the limit, these creditors were causing their credit card holders' scores to be and stay lower than what they really should have been, which kept them trapped, unable to qualify for higher-quality credit cards with lower rates. The best high-quality credit cards to focus on are offered by your bank or credit union, or are national cards such as American Express, Citibank, or Discover. We will not specifically name the cards that are not considered high quality, but if they spend a fortune on television commercials or are giving away unreasonably high "rewards" compared to others, they probably fall into this group.

Insight #3: Paying Off a Collection Account Will Almost Always Result in an Immediate Decrease in Your Credit Score, with One Exception

A collection account is an intriguing point of interest. Many people come to us and say, "Okay, I've been trying to fix my credit so I can buy a house, so I went and paid off my collection accounts." That could cause a real problem. Let us explain how the system works. With a collection account, the system looks at the "date of last activity" and assumes that date was when the collection account was posted in the system.

It doesn't differentiate between when it originally started and the date of last activity. If you happen to have had a collection account for three years that you just became aware of and are tempted to pay off, stop. First think about the short-term ripple effect of having the system think your recently paid-off, "old" collection is a new collection account. If your plan is to purchase a home or vehicle sometime in the next six to twelve months, don't pay your collection account off yet!

The moment that paid collection is reported to the bureaus, your score is going to drop. Instead, we can negotiate the payoff of the collection account with an underwriter so that you pay the collection off at the same time your home loan closes. This means you have settled the debt, and you have been responsible about your obligations, which makes the underwriter happy. At the same time, we have protected your credit score because it won't take the hit until after your loan has closed.

The exception to this rule deals with medical collections. As of July 1, 2022, medical collections that are paid are supposed to be removed from your credit report within two reporting cycles (60 days maximum). This is like negotiating a deal with the collection agency so that, as soon as you pay off the collection, they will remove it from your credit report. It's what we call a built-in "pay for deletion" because, once a medical collection is paid off, it gets deleted.

If used properly, this exception can help you increase your score dramatically in very little time. Additionally, as of July 1, 2023, any medical collection less than $500 can no longer be reported to the bureaus on your credit profile. As you can see, collections can be tricky, so please do not rush to pay off your collection accounts before you visit with us. We will consider all variables and help create your personalized plan to buy a home.

If you do pay off a collection account, you might unknowingly add an extra 6 to 12 months of waiting for your score to heal before you can get a home loan.