Charles Kirkland : Contributing Editor
Financial Advisor/ Loan Officer
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First Rules of Credit More Articles...
Life is a series of games, and to win these games you must first know the rules. One such game is the Credit Score. A novel little concept thought by most to somehow reflect the credit worthiness of an individual. . . . Not So.
The FICO score was originally designed to predict when you were going to file Bankruptcy, notice I didn't say if . . . I said WHEN. The higher your score, the further you were from filing. The lower your score the closer you were to filing. The concept is a simple one: if you first took everyone who filed for Bankruptcy, and second examined there behavior in the months before filing you would start to see similar patterns. You could then apply these patterns of behavior to anyone and predict how close they were to filling.
The Federal government required that this system be changed, but it is important to remember that the core of the program is still the same.
You see no-one really wants to file for bankruptcy, in fact most people do everything in there power to avoid it. One such common avoidance technique is as follows:
Your credit cards are near (or at) their limit, you make more than the minimum payment every month, but then you charge on the card again. In an attempt to stop this never ending cycle you come up with a great idea. “Honey lets close our credit cards, we can then continue to pay the same we have been and eventually pay this debt off”. Sounds good, but there is one major flaw, without the available credit you start to use your cash to survive and there is no money left at the end of the month to pay the credit card bill . . . OOOp's, your not the first to fail at this idea and usually within six months or so, your in a Bankruptcy.
Now lets apply that lesson (OK it's really a rule) to a practical application. You decided you no longer want or no longer using a credit card, so you voluntarily close the account. What happens to you credit score? That's right it goes down. For how long? about six months.
What are some other lessons (OK rules)? Anyone who tells you that running your credit does not lower your score is either lying or an idiot, either way you don't want to trust them with you credit The reason is simple. Let's pretend someone losses there job. On the way home they are worried about what to tell there spouse, then it hits them “how can I support my family for the next few months while I look for a new job”. Then the bright idea strikes - “There are only two people in the world who know I just lost my job, me and the jerk who just fired me. I know I have good credit so why not apply for some new credit cards, just to get through”.
Each time you apply for credit there is an inquiry and this will lower your score 3-5 points (but only for 90 days, because if anyone was dumb enough to actually give you a credit card they would have plenty of time to start reporting your charging and payment history by then). This brings us to another lesson (OK let's face it it's a rule) Opening of new credit will lower your score until you have proven that you can handle the new credit given to you. (that's about 6 months)
There are a lot of rules in playing the credit game, and it is important to win this game because it effects if you can get a mortgage and what rate you pay. Once you know the rules you can apply techniques that will help you improve your credit score and open up new opportunities.
For most people the largest single debt they will have is their mortgage, so if you can play the game to improve your score and the result lowers your interest rate even as little as 1/4% this would save $500 per year on a $200,000.00 mortgage.
It is important ant not to fall into the common traps of credit repair. Most people (and companies) who try to repair credit by removing derogatory items are usually doing more harm than good. Before contesting any derogatory information you should read my article entitled “Common Traps of Credit Repair”
A brief re-cap of this article gives us the first few rules of the credit game:
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Don't close any open accounts, unless you want your score to go down for six months.
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Don't let anyone run your credit (unless absolutely necessary).
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Don't open any new credit, within 6 months of getting a mortgage.
More rules to come.
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