An ounce of prevention, continued
Can we agree that I did a little better this time? This blog, as well myself, are a work in progress. I thank you for your patience.
So we left off talking about keeping your balances low, keeping your revolving and installment debt to a 1:1 ratio, and maintaining old tradelines where possible. One thing I’d like to expand on is balances. Like I said in my last post, try to keep your balance on a credit card at 15.89% or below. This is easier said than done, especially if you have a lot of high balances. A component of the debt threshold is overall debt. If you have three credit cards, and all your balances are below 15%, then it would follow that your total debt threshold is below 15%. This is ideal. If, however, you can’t do this on a per-account basis, then it is helpful is you could do this on your total debt. Let’s say you have three accounts.One has a limit of $5000 with a 0 balance, but you have two other cards with limits of $5000 that have a balance of $1000 each:
Balance Limit Percentage
Card 1 0 $5000 0%
Card 2 $1000 $5000 20%
Card 3 $1000 $5000 20%
Total $2000 $15000 13.3%
In this example we see that while you’re over the lowest possible threshold (15.89%) on two of the three cards, your overall threshold is below that. This total debt percentage is a component of FICO, so if you can’t do it on each account, strive to maintain this threshold on your overall debt. To this end, don’t be afraid to ask your credit card company for a limit increase. The higher your available credit, the lower your percentage, provided you don’t run up the balances. Use restraint, people!
Another huge component of FICO is inquiries. I’ll probably dedicate a future post just to inquiries, but for now let’s just try to avoid these. They stay on the credit for 24 months, and have an impact on FICO for all 24 months. The more recent the inquiry, the more it hurts your score.When you check your credit through www.annualcreditreport.com, it doesn’t count as an inquiry. If anyone else checks your credit, it does count. There are some types of inquiries that don’t impact your score, but these “soft” inquiries are the exception, not the rule. One final note on inquiries; when you’re shopping for a mortgage or vehicle, you will no doubt have the loan officer or salesperson tell you that these types of inquiries don’t hurt your credit, or you’re given a “window” of time while you’re shopping to have multiple inquiries blocked together and treated as one inquiry. For the most part, this is patently false. This is only true in the NextGEN FICO model, and 89% of all mortgage companies pull credit using the Classic FICO model, and in this model, each and every inquiry will bring down your score. If you’re shopping, find out what your FICO is, and tell the salesperson or loan officer. They can give you a rate quote based on an assumed score.
An ounce of prevention
Greetings all. I’ve been terribly busy, so I apologize for not posting more regularly. I’d like to tell you it won’t happen again, but we all know it probably will. I will endeavor to be better about it. Anyway, we left off discussing what can be done about removing derogatory items from your credit report—both what you can do, and what a professional can do. We know the bureaus make mistakes, in fact we know they make them on 4 out of 5 credit reports. We now know you can have items removed from your report—both the mistakes as well as any other item, if you’re dogged enough or you’re working with a good credit repair company. What I’d like to do is back up a bit and talk about what can be done to maintain a healthy credit profile to begin with. There’s a lot of confusion and misinformation out there about what makes a good credit score.Let’s start with the basics. The higher your score, the more bureaus and creditors think you have the ability to pay your debts in a timely manner. So the biggest thing to avoid is lates, collections, charge offs, bankruptcies, etc. We all know that, so let’s talk about the other things.
Keep your balances small in relation to your limit. This is another thing that causes confusion. Most people will tell you to keep your balance below 50% of your limit. The truth is there are balance thresholds. If you’re above 88.78% of your limit, you’re considered maxed. This will suppress your score tremendously. Having a 50% balance is better than being maxed, but not as much as some would have you believe. The true threshold you want to be under is 15.89%—anything over that percentage will harm your score. There are many creditors out there that don’t report your limit, so your high balance (the highest your balance has ever been) is reported as the limit. The scoring models have no choice but to use your high balance as your limit. Let’s assume you have a $5000 limit on a card. You’ve never charged up more than $1000 on it, and carry a balance of around $500. Well, if that creditor reports to the bureaus that you have a balance of $500 and your limit is $1000, that credit item is doing more harm than good to your credit. Pay those down and don’t use them.
Try to keep your revolving and installment items at a 1:1 ratio. A revolving item is any credit card. An installment loan is a mortgage, vehicle, or any item that has a term. If you’ve got a home loan, a car loan, and you financed a new dinette set for 36 months, try not to have more than three credit cards. If you can maintain this ratio your scores will increase. If you go above 5:5 on accounts, then your score will start to be harmed again.
The longer you have an item on credit, the better. A card that you’ve had for 10 years is better for you than a card you opened two years ago.Don’t close a card. It’s OK to have a 0 balance on a card and not use it for up to 12 months. After 13 months this account with no activity will begin to suppress your score. So, if you have a “rainy day” credit card, use it at least once a year and pay it off, but don’t close it.
This is turning into a bigger topic than I anticipated. I’ll expand on this further soon, I promise (for reals).
Need a mechanic?
As mentioned, there isn’t any derogatory item that appears on your credit report which you can’t dispute on your own. You don’t have to be knowledgeable about engines to change your oil. A first dispute isn’t any more difficult to do than an oil change. You’ll find that many older items will come off right away because the creditor can no longer validate the account.You’ll also see items come off just because of non-response. More recent derogatory items, however, are less likely to come off on an initial dispute. These need to be addressed by a second dispute, but most people won’t have any more success on the second dispute than the first. An oil change isn’t going to cut it. You need some engine work, and it may behoove you to have a mechanic do the work for you. It’s possible to learn everything there is to know about an engine and do the work yourself, but you’ll likely be better served not to spend the time necessary to do all that learnin’ and let a professional handle it.
Credit repair agencies have a pretty bad reputation, and deservedly so. Nearly every single one of them purchases software that tells them which disputes to file, and where to file them. When you sign up with them, they’ll send you templates for form letters to fill out and send to bureaus and creditors. Why would you pay for that? That’s like your trusty mechanic telling you how best to go about fixing your engine after you’ve paid him to fix it, and then handing you the wrench. In my experience, the best credit repair agencies are the ones that have an attorney file disputes, on their letterhead, directly to the bureaus and creditors. That gets the bureaus attention, and more importantly it adds teeth to the process. The bureaus know that in order to have any disputed item remain on the report is going to cost them money—eventually even legal fees. As stated in a previous post, the bureaus are for-profit organizations. Their bottom line is their bottom line. Why would they want to incur legal expenses on behalf of creditors? They don’t. As you can imagine, retaining your own attorney can get quite expensive, but there are associations out there that pool their member fees to pay the attorney for you to minimize the expense. This is a viable option if you have items on the credit that aren’t necessarily there because of an error. These items are harder to challenge on your own, and you’ll likely receive far better results letting someone who not only knows everything there is to know about the statutes and acts that protect you, but knows how to get the bureaus to acquiesce and remove those items.
It’s got to hurt if it’s to heal
I know my first few posts were pretty cynical. That wasn’t my intention. I needed to be clear that there is a very real issue, and the bureaus themselves are doing nothing to solve it. I suppose that is rather cynical, but that needed to be conveyed. The news isn’t all bad. I mentioned the Fair Credit Reporting Act and the Fair and Accurate Credit Transactions Act in my first post. These acts were passed with consumers in mind. Those two acts, along with the Fair Debt Collection Practices Act empower consumers to fix their own credit. I can already feel your eyes glazing over, so I’ll spare you the drab details of those acts. Look them up if you’re feeling adventurous. The important thing for you to know is that there are mechanisms are in place to extend a middle finger to the credit bureaus, with the latter act giving you the opportunity to extend a middle finger to the creditors and collection agencies themselves with your off hand.
Engine problems? Can I interest you in wiper fluid?
As highlighted in my previous two blog posts, there is a very fundamental breakdown occurring with our current credit model. The issue is manifold, the bureaus, more than any other entity, have it within their power to correct some, if not all, of the problems plaguing the system. Rather than devote their energy and resources to correct the issues endemic in the system, the bureaus have instead focused their concentration on the scoring model.
Fair Isaac Corporation is the company behind the scoring model for all three credit bureaus. Many people have heard of a FICO score, but whether it’s called a FICO score, an Empirica score, or a Beacon score, Fair Isaac does all the scoring. The scoring is based on an algorithm that Fair Isaac developed, and I daresay more people know the Colonel’s secret recipe than know the components of the algorithm that they have developed. What exactly what goes into the model isn’t public knowledge, and in fact the model is different depending on what type company pulls the credit. If you got a score directly from one of the bureaus, that score would be different than a score obtained if a mortgage company pulled your credit, and different still if a credit card company pulled the credit, or an auto dealership did. The bottom line is that while the numeric score may differ depending on where you obtain it, someone has to pay to see the score. Their scoring model is so pervasive that, “two-thirds of the top 100 banks in the world, 90 of the 100 largest financial institutions in the U.S., and all the 100 largest U.S. credit card issuers” use it. Fair Isaac makes a very good living assigning a numeric value to every single American. Business is so good for Fair Isaac, the credit bureaus want a piece.
Rather than fix the sundry issues with the content of their credit reports, the bureaus have decided something needs to be done about scoring. To be clear, the issue is not how a collection or slow pay is scored, but the fact that it’s been placed on the report erroneously to begin with. Enter the three bureaus with a solution to a problem nobody had, a brand new scoring system! The big three teamed up in an effort to force Fair Isaac out of the credit scoring business, in favor of the adoption of their very own scoring system, VantageScore. Behind the scenes the three bureaus are pushing really hard for the adoption of their model, which as far as anyone can tell differs very little from Fair Isaac’s model. The reason you’ve all probably heard of a FICO or Beacon score, but have likely never have hear of a Vantage score is because they can’t get the big Credit Service Organizations, banks, and mortgage companies to sign off on it. Mark my words, with the bureaus having a 100% monopoly on the content of credit reports, sooner or later the powers that be will acquiesce and begin utilizing Equifax’s, Experian’s, and TransUnion’s love child.
“Fair” Credit Reporting continued . . .
As mentioned in my previous post, the credit system itself is flawed. From consumer understanding, to the premise that these repositories of information sell said information to any bidder (regardless of the veracity of the information). More alarming perhaps is that the bureaus themselves do a particularly bad job.
One would think that if your only job is the collection and dissemination of credit information, you would make damn sure that the information is accurate. The bureaus would have you believe that by and large they get it right, and that mistakes are the exception rather than the norm. In 2004 the Public Information Research Group, PIRG, found that 79% of credit reports had “serious errors or other mistakes of some kind.” Nearly 4 out of every 5 credit reports are just plain wrong! This raises two questions, what impact is this having on the average consumer and how does the system itself have any integrity if the information being disseminated is incorrect?
The impact to most consumers cannot be overstated. Most people don’t even know what’s on their credit report until they apply for a loan. Then they end up having to pay a higher interest rate on a mortgage, a car loan, a credit card, or even a higher insurance premium because of a lower credit score due to inaccuracies. The study by PIRG that I cited earlier found that “Twenty-five percent (25%) of the credit reports surveyed contained serious errors that could result in the denial of credit, such as false delinquencies or accounts that did not belong to the consumer.” So while many end up paying a higher rate of interest, one in four simply may not be able to finance anything at all, through no fault of their own. While most people are unaware, not all are. The three bureaus between them have more Better Business Bureau complaints filed against them than any other industry. In fact, they have more BBB complaints then the 2nd and 3rd leading industries combined. Those are just the people that recognized the problem and reported it. They represent a tiny fraction of the population. This problem isn’t going away. The bureaus should be doing everything in their power to correct this on their own. My next post will be dedicated the TransUnion’s, Equifax’s, and Experian’s latest pet project.
“Fair” Credit Reporting
I’m constantly amazed by our current credit reporting system and its failings. There’s plenty of blame to go around, from a Congress more concerned about who cheated in a baseball game, to an uninformed populous, to inept bureaus controlling the information on credit reports.
To Congress’ credit, they at least put a good face on it with the passing of the Fair Credit Reporting Act (FCRA) in 1996, and the Fair and Accurate Credit Transactions Act (FACTA) in 2003, although it could be argued that FACTA hurt consumers as much as it helped by stripping away specific state-level consumer protections (I’ll expand upon this in a future blog post).
I find that most people think that the credit bureaus are somehow run by the Federal Government, or are some sort of non-profit organizations. The bureaus of course, are for-profit corporations no different than any large corporation, with the exception being that they contain the personal data–ranging from credit card info, to mortgage histories, to current and previous work and home addresses–for 90% of Americans. By and large, the average person has no idea what data is on their credit report. You can get a free one every year, and cross your fingers that mistakes happen on a regular annual basis. The bureaus–the good-natured sort that they are–will inform you when derogatory items are placed on your credit report, if you pay them an annual or monthly fee. That’s just grand, they’re collecting your personal information without your permission and you need to pay them for the privilege of knowing exactly what info they’re releasing to anyone willing to pay their fee, regardless of the accuracy of that information.
It’s an issue I’ve been thinking quite a bit about after a decade in the financial services sector. I intend to write more about it in the next couple of days, so stay tuned for my next missive, when I’ll write more about just how the system is flawed and possibly worse yet, how the bureaus themselves do a really bad job of reporting data accurately.