Having spent a combination of 13 years in both the community and corporate banking atmospheres, I have become aware of the most important factor for acquiring a loan – be it commercial, agricultural, personal or home – and that is to have a “good credit rating.” For many this term is a black hole and I hope to make it simpler to understand in this article.
Of the 5 C’s of Credit, which are Capital (down payment & overall equity), Capacity (cash flow to service debt obligations), Character (integrity & reputation), Collateral (assets to secure the debt) and Conditions (the terms of the loan and overall economy), the most important to me is Character. A Creditor can calculate a person’s net worth, cash flow ratio, & collateral coverage ratio. A Creditor can also weigh the Conditions of the loan based on their financial institution’s lending policy, but the hardest factor to calculate is a person’s Character, which brings us to the credit score! A person’s credit score can be a good indicator of a person’s “financial” character and how well they manage their finances.
Credit Score Tips
*Note: As I use the term “weighting” throughout this section, I wanted to give a brief explanation or definition of this word. The FICO credit scoring system grades borrowers on a range from 300 to 850. As an example referencing #1 below, Payment history accounts for a 35% weighting – meaning 35% of your total credit score is based upon this factor alone.
- Payment History – Make your payments on-time.
At a 35% weighting*, your payment history is the most important part of your credit score. A late payment can affect your credit score for at least two years. One 30-day late payment can drop your credit score 40 to 110 points and one 90-day late payment can drop your credit score 70 to 135 points.
- Amounts Owed – Pay down your balances.
At a 30% weighting*, if you carry a balance on your credit cards over 30% of your credit limit, it can lower your score. To improve your score keep your balance under 30% of your credit limit, 10% is even better.
- Pay Early – Consider paying a portion of your credit card balance early.
If your balance will be over 30% of your credit limit at the end of the month you may want to make an extra payment to lower your balance.
- Credit History – Try extending your credit history as long as possible.
At a 15% weighting* the longer you can maintain an open and satisfactory account the more it will help your score.
- Credit Inquiries – At a 10% weighting*, applying for new credit results in credit inquiries which remains on your credit report for 2 years and can lower your score.
- Types of Credit – At a 10% weighting*, diversifying your credit mix can improve your score. If you only have a credit card and no installment loans such as an auto loan or mortgage loan then your score could be limited.
- Collections – If you have a Collection account – Dispute it and/or get it paid.
Collections can remain on your credit report for seven years and have a severe negative impact on your credit score. If you pay off a collection make sure your creditor reports it as paid on your credit report.
- Judgments – If you have a judgment get it satisfied or vacated. Judgments are public record and can be viewed by potential employers or creditors.
Judgments are reported on credit files for at least seven years and will remain on public record until satisfied. In addition, judgments can drop your credit score up to 150 points. If you pay off a judgment make sure your creditor reports it as paid on your credit report.
- Foreclosures, Short-Sales or Deed-in-Lieu – A foreclosure, short-sale or deed-in-lieu of foreclosure can stay on your credit report for up to seven years and can drop your credit score 85 to 160 points.
- Bankruptcy – A Bankruptcy can lower your credit score 130 to 240 points and can remain on your credit report for at least seven years.
Credit reporting agencies have been under criticism because of inaccurate information. It is wise for you to review and check your credit score at least annually or more often. Here is a web link www.annualcreditreport.com.
If your credit score isn’t where you want it to be, do your research and/or seek advice and guidance from trusted sources. Your local community banker is usually a good place to start!