It's Smart To Know The Score On Credit
by Kathy Kristof
Sam
Warnken is a financial genius at least when it comes to managing
his credit.
A Santa Barbara, CA,
house painter with a mathematical mind, Warnken was among the
few people to get a perfect score on a recent nationwide credit
quiz. But the 25-year-old maintains that the test barely scratched
the surface of his knowledge.
"You'd be surprised
by all the things I know about credit," he said.
He knows, for example,
that paying off an old collection account could damage your credit
score the figure that helps determine the interest rate you'll
pay on a loan and that some lenders can damage a consumer's credit
by not reporting all the information they have available. More
important, Warnken knows how to fix these glitches to boost his
credit score and boost his chances of getting the best loan at
the best price.
Warnken started studying
credit to help himself and some friends get lower-cost loans.
Now, he's so good at boosting credit scores that he may turn
it into a sideline business.
As home-buying season
kicks into high gear and mortgage refinancings continue to soar,
thousands of dollars can swing on a consumer's credit savvy,
said Steven Foster, president of Vista Financial, a mortgage
brokerage in North Hollywood, CA. It makes sense to spend a little
time this spring getting credit-smart like Warnken.
Here are credit tips
from Warnken and other experts.
How Lenders React To Your Credit Score
The
most commonly used credit score, known as FICO and created by
Fair Isaac Corp., is a number between 300 and 900 that tries
to gauge a consumer's propensity to pay his or her bills. In
theory, a least, the higher the score, the more creditworthy
the borrower.
Credit scores have
a marked effect in the mortgage market. Borrowers who score above
set FICO thresholds get lower-rate loans and special privileges,
Foster said. Here are the relevant thresholds:
Score higher than 700
and you not only get the best loan terms, but lenders also may
make the loan without asking questions about your income and
assets, Foster said. So-called "no-docs" loans make
the loan process faster and easier.
Score 660 or better
and you get the best rate from virtually all lenders, but you
will have to provide documentation of your income, assets and
debt.
Score between 620 and
660 and you may get a preferred-rate loan, but you'll have fewer
lenders competing for your business, Foster said. Those lenders
also will look more closely at the nature of the transgressions
on your credit report to determine whether to push you into the
dreaded sub-prime market. Lenders
consider anyone with a score of less than 620 to be a sub-prime
borrower. Those borrowers pay at least 1 percentage point more
in interest on a home loan and may have to accept unattractive
loan features such as prepayment penalties. Just the percentage-point
difference in the interest rate would cost $23,410 for each $100,000
borrowed over 30 years.
Factors That Can Lower The Score
The
things that most damage a credit score are bankruptcies, foreclosures
and collection accounts, as well as late and missed payments.
But Warnken said credit scores also can be lowered by unexpected
causes such as having just a few heavily used credit cards.
Someone with $5,000
in debt will score far lower if that debt is on one credit card
charged to the limit than if the debt were equally divided among
two or three credit cards that each had a $5,000 limit, for instance.
Moreover, not having
certain types of debt can hurt. To get a high enough score to
rank as a preferred borrower, a consumer generally must have
both credit card and installment loans, Warnken noted.
Consumers who don't
have a car loan or other installment debt can boost their score
by getting a low-cost loan secured by a bank certificate of deposit,
Warnken said. This is particularly effective for those trying
to establish credit, because it's relatively cheap the bank doesn't
charge much for the loan because it has no risk.
Consumers also should
look for oversights on their credit reports, such as lenders
failing to report the borrowing limits on their credit cards
or lines of credit.
Scoring programs compare
the amount of credit available to the consumer with the level
of overall debt. When accounts are posted without credit limits,
the program assumes the loan has been charged to the maximum,
which boosts the consumer's debt ratio and lowers the score,
Warnken said.
Bad Advice Can Hurt Your Credit
Some
common notions about how to improve credit can do more harm than
good. Some advisors tell consumers to cancel unused accounts
to lower the amount of credit available, thinking that will help
their score. But it frequently does the opposite, said Craig
Watts, a spokesman for Fair Isaac.
A portion of the FICO
score is based on the length of the consumer's credit history.
But the score measures only what's in the report. Consequently,
a consumer who cancels all old credit card accounts appears to
have a shorter credit history, which hurts the score. Moreover,
it raises the consumer's debt-to-available-credit ratio which
can also hurt.
Those with a large
number of accounts may be forced to close some by nervous mortgage
lenders concerned that the consumer will be over-indebted if
all those cards are charged to the limit buying furniture for
a new home. But to keep a good credit score, the consumer should
leave the oldest accounts alone, Watts said.
Another misconception
is that to get a home loan, the consumer should pay off old collection
accounts, such as the disputed $12 bill from the mail-order record
company. Huge mistake, Warnken said.
The reason: The score
gives more weight to recent activity. A 6-year-old collection
account, consequently, would have a relatively small weight in
the overall credit score. But make a payment on that old account
and it shows as current collection activity. That can shave dozens
of points off a FICO score.
Editor's Note: Kathy
Kristof, a Los Angeles Times business writer, reports
on a wide range of personal finance issues. She offers specific,
actionable advice knowledge about handling finances successfully.
In addition to writing, she is a frequent lecturer at investment
conferences. She's also appeared on a wide variety of radio and
television news programs.
© 2003 Tribune Media Services, Inc.
