What is Credit?

Credit, in its simplest form, is defined as someone’s financial reputation.  In order to maintain a good financial reputation you must work at it; and the more you do for it, the better your credit rating will be.  Credit worthiness takes time and patience before it can begin working for you, and the longer you show financial responsibility with your obligations the better your financial reputation will be.

Most people when applying for a home loan will simply focus on their credit history as the primary determinant in qualifying.  Credit does come into play; however your credit history is only one of the measurements used by lenders to qualify you for a home loan.   By itself, good credit can not qualify you for a home loan; however without good credit your ability to qualify will be hindered.  That is why we put together some basic information you should know in order to maximize your credit score potential. 

Most lenders will begin their credit analysis of an applicant by pulling a credit report.  The credit report accessed by your lender can be acquired from a number of companies.  These companies often refer to themselves as credit vendors and will only work in relationships that are tied directly to the lender.  Our company currently uses Credit Plus for the issuance of credit reports.  It really does not matter which vender a lender uses to pull your credit report, the information listed in the credit report will be similar regardless of which credit vendor is used.  Once a credit report is pulled your lender will analyze the information on the report to determine your ability to credit qualify.  I always give my applicants a free copy of their credit report and if time permits I will go over the report thoroughly to ensure you have an appropriate understanding of the report.

Each lender will get your credit history from three primary reporting agencies: Equifax, Experian, and Transunion.  The scoring formulas used are complex and unpublished so that it cannot be replicated or manipulated.  I can’t tell you why it is such a hidden secret, but if you work with the reports long enough you will gain some important insights on how each reporting agency scores your credit information.  You may notice that the scoring will be listed next to each reporting agency; this score will be the agencies score card for your credit history.  The higher the score the better your credit history will be.  Most credit experts will agree that the credit report score will indicate the level of risk associated with the applicant’s ability to pay their obligations on time.

Credit is a complex measurement used in determining a person’s ability to pay on credit terms extended to them by a number of financial institutions or entities.  The financial reputation of a person’s credit history will be dictated by a grading component found on all credit reports. The grading component is known to be displayed as a credit score. The credit score will be used to assess the credit risk of the applicant applying for financing terms.

In order to understand the calculations used in determining a person’s financial reputation, a thorough background in credit report analysis will be needed. However, most people simply need to know that if you pay your credit obligations on time and as agreed the financing terms you are looking for will be provided to you with limited issues. Your credit qualifying segment will be approved and you will move on through the process.

Credit scores will typically fall anywhere between 350 and 850. The lowest credit score I have ever seen for an applicant was 386, while the highest score to come out of our office was 835.  The average score for most credit applicants will fall between 640 and 690.  In order to credit qualify based on score alone, you will need at least a 600. Though 600 can technically qualify you for a home loan, lenders are pushing for at least a 620 or higher.  Each credit agency will have its own score to report, giving the credit report three credit scores. The credit qualification process only uses one score to qualify, so how do the lenders determine which score to use? Fortunately, lenders have maintained a consistent policy as it relates to what credit score to use. After reviewing all three credit scores lenders simply remove the highest score and the lowest score. The remaining score will be used in the credit qualification process.

The credit report will be broken down into a number of sections each section serves a specific function for reporting our credit information. 

1. 1.      Section (1) Your personal information

The credit report will start off by having your personal information listed, such as name, social security number, date of birth, and address.  It will also have the name of the vendor and a reference number know as a credit report number.  Obviously most people don’t focus on the personal information much, except to make sure that the credit report is actually their report. 

1. 2.      Section (2)  The account detail section

The most critical portion of the credit report will be the detailed history of your current and past credit obligations which will be listed one by one in the account details section of the credit report.  Each account will be listed individually with the following information attached to it:  In order to fully understand the details listed in this next section you may want to have your actual credit report in front of you, so that you can follow along.

1. The name of the account and the account number will be listed first. The account number on the credit report may not be the same account number you have on your actual account, but in general it will match.

1. Immediately following the account name and number you should see the month and year you opened the account and the month and year of your most recent activity on the account.

1. The next item listed should display what your current credit limit for the account is and the number of months your account has been opened.

1. The type of account you have will be listed next.  There are a number of different account types, but the most common account types you will see on your credit report will be listed as; installment, revolving, auto and mortgage.

1. You may have noticed by now that there are a number of columns showing the numbers 30, 60, 90, and 120.  These columns represent the accounts delinquency history and will report any delinquency you might have had for this account.  Delinquency is defined as any payments posted to your account greater than 30 days, 60 days, 90 days or 120 days.  Consequently, the number of late payments you have can have a negative impact on your account history; however, the magnitude of how this might affect your credit score depends upon how late the payments were.

1. Moving beyond the delinquency information section you should see your minimum payment requirements and any past due amounts you might have.   Finally to complete the account detail section you will see your total remaining balance due for the account.

1. 3.      Section (3)  Public Record Information

Following the account details section, the credit report will display any public record information filed on your behalf.  The public record information might include items such as any Bankruptcies you might have had, and Judgments filed against you by a creditor, and finally, any State or Federal Tax liens recorded against you.

1. 4.      Section (4) Derogatory Account Details

Following the public information section you should see any accounts you might have had that was sent to collections.  The Derogatory Account Details section will be similar to the account details section which we discussed earlier, but in this section only derogatory information will be listed.  These accounts will typically show up numerous times depending on how often they were bought and sold by other collection companies.  You will normally need to resolve the accounts listed in this section, but talking to a credit specialist may help you resolve these accounts faster then trying to do it on your own.

1. 5.      Section (5)  Account Information section

The remaining information on the credit report deals with informational pieces that will serve as a reference to the account detail information already displayed.  You should find this information at the very end of a credit report. The information portion is the most overlooked section in the credit report, but can provide you with some critical information.  Here are some of the items you can expect to find near the end of your credit report.

1. The name, address, and phone numbers for all the creditors listed on your credit report.

1. Credit inquiries which tell you who pulled your credit and when they pulled it.

1. The name of the credit agencies and all of their contact information, in the event you want to dispute anything currently listed on your credit report.

1. Finally, any disclaimers the credit vendor may have in relation to pulling your credit report from the credit agencies.

This pretty much concludes anything you might see on your credit report.  Now that we know a little bit about what is listed and how to read the credit report we can finally begin to talk about how to positively impact your credit scores.  Over the years we have accumulated a number of techniques to help applicants understand how their scores are calculated.  However, because the formulas used to calculate the credit scores are unpublished we need to note that the information we are provided on credit score analysis is based on our opinions only rather then fact.  We have researched these topics in great detail and have personally used the information to positively impact credit scores, but working with a credit specialist will always be our final recommendation.  So with that said, let’s start talking about my favorite topic in credit analysis and that is how we believe the credit agencies determine credit scores.  By understanding how these credit agencies score credit we can manipulate the areas we can control to maximize your overall score.  Remember the higher your credit scores are the better your home loan options will be.

Any time I am involved in a discussion about credit I am asked: how are credit scores determined?  How can I improve my credit score in the shortest amount of time?  The components making up a credit score can be extremely complicated.  The fact that the exact calculations used are not available to the public makes it even more difficult.  I have participated in a number of credit improvement seminars and have researched the credit scoring criteria extensively and through this research I have been able to develop a few observations that may be a benefit to you.

The first step to improve your credit scores is to understand what drivers affect credit scoring.  Common sense will tell you that if you are not meeting your current credit obligations responsibly you will have a poor credit score.  For example if you have any; collections, late payments, judgments, liens, or bankruptcies you will have a lower credit score then those who do not have these discrepancies listed on their credit reports.  How far your credit score drops will depend on the severity and the number of negative items you have listed on your credit report.  Trying to work around these issues is why I recommend using a credit specialist.  I just do not have the information needed to help disguise, or eliminate derogatory credit information.  What I can do is help you understand the credit scoring criteria and with that information help improve your overall credit score by maximizing the scoring system in your favor.  This is where we will focus our attention on.  

1. 1.      The total amounts owed on your accounts are too high.

This works in conjunction with your current credit limits.  If your total balances on your credit accounts exceed 80% or higher as it relates to your credit limits, then your credit score will typically drop.   Credit agencies will typically have a neutral scoring calculation if your credit balance falls between 35%-80% of your credit limit.  Finally, you should see your credit score improve for any accounts having a balance that drops below 35% of the high credit limit.

When you look at your credit report and see accounts that have balance near or at the maximum credit limit, your credit score will be negatively impacted.  All you have to do in these circumstances is pay the balances down below the 35% range.  This will change your rating from negative to positive overnight.   Obviously this may not be as easy as it sounds, especially if you’re stretched thin as it is.

This is where we begin to manipulate your accounts to help drive down your overall percentages (%) related to your credit limits.  The first thing you might want to try is to call your credit companies and ask for an increase in your credit limits.  This is especially true on low credit limit cards. Increasing your limit can drastically improve your current percentage (%) ratios, and most credit companies can approve the increase right over the phone.  This is especially true if you have had an account with them for some time without having any derogatory history with them. The improved ratios will turn a current negative reading into a positive one.

1. 2.      You don’t have enough revolving accounts; basically your credit history is limited.

It appears that every mortgage broker offering credit counseling will have some type of opinion related to the number of revolving accounts you should have.  I work with credit repair companies for years and can always refer you to them, but here is what I know about revolving accounts.

In order to achieve the optimal credit scoring you should have around three to five revolving accounts.  There are some drawbacks when attempting to meet this criterion.  I have seen scores actually drop in the short term as clients have attempted to get new revolving credit accounts.  Over time the problem will be minimized and your credit score will likely improve by having the right number of accounts on your credit report, but it takes time to have the right number of accounts improve your credit score.  Most applicants need the boost much quicker then using conventional means to achieve this goal.  So what else can be done to help resolve this issue?

 One unconventional way to improve the total number of revolving accounts is to talk to a friend or family member.  Your friends and family can have you added to one of their revolving accounts as an authorized user.  All they will need to do is call their credit card company and ask them to add you to the account.  To ensure you are listed as an authorized user creditors will need your social security number.  By using the authorized user approach all of the credit history tied to your family member’s credit card will be added to your report.  So, if they have had the credit card for a number of years, the total months revolving will actually improve your credit score along with having the right number of revolving credit accounts listed on your credit report.

3.  Having too many accounts with balances can

     affect your credit negatively.

If you have 15 accounts that all have balances tied to them, then the credit report scoring will report negatively. The best thing you can do in these circumstances is to pay them off; start with the lowest balance cards first and pay them off one by one as you can.  What you are trying to accomplish here is a reduction in the number of credit accounts you have. It makes no difference what these accounts are--your goal should be to pay them off in full.

Again you might find yourself in a situation where paying off your accounts might not be a viable option for you.  If paying your accounts off in full becomes difficult you may want to try a different technique. Determine if consolidation of your accounts is an option.  Most of your credit cards will give you the option to transfer account balance to other credit cards.  If you have the credit limit to support the transfer, then go ahead and transfer the account balances. You will run the risk of having high account balances, but leaving your accounts open should help off-set some of these negative impacts.

You may also want to try and qualify for a debt consolidation loan to help pay off a number of credit card accounts by consolidating them into one simple installment loan. This should be self-explanatory and as long as you have been responsible with your credit, lenders should be open to this request.  Think of it this way: if you reduce the total monthly obligations, then you win; and if the lender gives a loan to a credible applicant with a low default risk, then they win.

1. 4.    Using opt out prescreen to limit the number of creditors looking at your credit can also have a positive impact your credit score.

There is much debate on whether this works or not, but we have recommended this to a number of applicants trying to improve their credit and have seen firsthand the improvements. You will need to go to the website www.optoutprescreen.com and it will give you the option to opt out for life or a period of five years. We recommend using the five year option, because no additional paperwork will be required.  If you elect to use the life time opt out feature you will need to print the form and mail it in.

Hopefully the information we have provide here will help you access your current credit report and help determine the best strategy for improving your credit score.