Credit

FIRST OF ALL, I want to thank everyone who viewed the 1st blog that as of August 30th had 101 views! AWESOME!

Unless you are a MILLIONAIRE or BILLIONAIRE you will need to use credit at one point or another in your life (and and even some of them still do). Mark Zuckerberg even financed a house (at a 1% variable rate) that he could easily have paid cash for. Anytime you finance something you are using credit provided by someone else and therefore reported to the credit bureaus (Transunion, Experian and Equifax).

But do you know how your credit is calculated? 

The basic answer is:

1.) 35% is your Payment History

2.) 30% is the Amounts Owed

3.) 15% is Length of Credit History

4.) 10% is New Credit

5.) 10% is Types of Credit Used

The more detailed answer is:

1.) You want to make all payments on time, preferably BEFORE the due date. Usually items are not reported as lates until they are 30 days past due. This does not mean you can consistently make payments on the 29th day after they are due. Companies will begin recognizing your late payment history and can start reporting items as late, prior to the standard 30 day grace period. In addition, they can charge you additional fees.

2.) The amounts owed are relative to the credit limit. This means that a $5,000 balance on a credit card with a limit of $50,000 is MUCH more reasonable than a $5,000 balance on a credit card with a limit of $7,000. Over different articles I have read, the max credit limit ratio (amount owed divided by credit limit) is between 25% and 35%. There are a few additional notes on this matter. 

     a.) Balances are reported at the end of billing cycle. When it says you owe $2,500 on a card with a limit of $5,000 your reported ratio is 50%. Even if you pay it off each month and have never paid interest, it can still hurt your credit score carrying a limit monthly limit ratio.

     b.) It IS allowable to make payment on credit cards more than once a month. As a point of matter, I do this frequently. I NEVER allow my ratios to exceed 20% at any one time UNLESS it is a large single purchase. Even when I do, I make payment on it immediately. This is much easier if your credit card is through an institution that you bank with.

    c.) If you owe $0 (either by paying not using the card or by paying the balance to $0 before the billing date comes due), your balance will obviously be reported as $0. If your balance is reported $0 too many times, the institution that holds your line of credit can stop reporting it to the credit bureaus. You do NOT want this to happen because this decreases your available credit as shown on the credit report, decreases your average length of credit history, decrease the amount of good payment history and limits the different types of credit used.

3.) Your average length of credit history is important because if you have longstanding credit with one source, it shows that you are a good borrower. If you weren't, they wouldn't continue to extend you credit. 

As an example, if you have 4 different lines of credit with lengths of time since opening: 12 Months, 28 Months, 56 Months and 84 Months, your average length of credit history is 45 months. If you were to close your credit line of 56 months, your average would drop to 41 months. Someone that has an average history of 45 months vs 41 months shows they are a stronger borrower.

4.) There are two ways new credit is judged on your credit report:

     a.) Recent inquiries - The more recent inquiries you have, the more it shows you are trying to get credit. This is not a bad thing, but if you have too many inquiries in a small time frame it can be a sign you desperately need credit which IS a bad thing.

    

     b.) Additionally, as previously mentioned, new credit decreases the average length of credit history which is not a good thing.

5.) Historically speaking, different TYPES (car, mortgage, credit card, student loans) of credit represent less risk to a lender. If you can handle a steady set payment (car aka installment) and a credit card (unsecured debt), it shows that you are responsible and helps your credit score. This doesn't mean open up a car loan just to increase the mix of loan types because at the same time it may hurt your score. This is due to the previously mentioned new credit and balance to credit limits.

Simply - If you make your payments, keep lines of credit open and keep balances relatively reasonable you will have a good credit score. However, I have looked at almost 200 credit reports in the last year and this is not always the case...

THE MOST IMPORTANT THING:

Make sure information is ACCURATE on your credit report. Your score is what it is, but you must make sure it is accurate. The best way to do this is to Check Your FREE Credit Report annually. This is the best and most legitimate site to do this. It will NOT tell you your score, but you do get a free report once a year from each bureau. My recommendation is to check each bureau every 4 months. For example, in January check Experian, in May check Transunion and in September check Equifax. This way you get to see the whole report 3 times/year. There's no sense in checking all 3 at the same time because the information will be almost identical.

To receive a FREE and CONFIDENTIAL personal financial assessment, email me at davids@eqfin.com.

Next week: How to read a Credit Report