Thursday, December 13, 2007

Fran's Guide to Obtaining and Maintaining Excellent Credit.

One of things that I want to explore in greater detail is the concept of credit.
How do I obtain credit?
How do I check my credit history?
How can I repair any errors in my credit report?

Perhaps ipoint could look into getting an alliance with a group that can help our client base increase and maintain their credit scores so we have a stronger overall group to learn together with, and perhaps run joint ventures with.

In my travels I ran into an excellent credit article in a forum. With the author's permission, I've re-posted it for people to share in. Hopefully someone can "Canadianize" it and re-post it as an article for the ipoint group. Either way, at least I'm taking the steps to learn about the wide world of finance from all of its facets.

In America, your credit is based on credit history. The longer you have credit, the more prompt your payments, and the lower your balances, the better credit you will have. Unfortunately, having no credit is usually just as bad - and in some cases worse - than having bad credit.

Why Credit is Important

It seems that the old days of paying for everything with cash are gone. Doing so these days will actually cost you additional money - potentially thousands of dollars. Your credit - like it or not - plays a huge role in many things that you do. It affects your insurance rates, is utilized by many apartment complexes to approve tenants, obtain credit cards, vehicle loans, and mortgages. Recently, quite a few employers have recently started screening for potential employees by examining their credit. The fact is, it is hugely advantageous to have a high credit rating, and likely will make life much easier on you - not to mention much less expensive in the long run.

The difference between good and bad credit on large purchases is tremendous. A person with a poor credit rating will generally pay tens of thousands of dollars more in interest than someone with average credit, and a person with excellent credit will pay even less.

The Credit Reporting Agencies
There are three main credit reporting agencies. Some institutions use what are called tri-merge bureaus, which is pulling information from each bureau and combining it into one. Others use individual CRAs, which usually vary by the area. In the Midwest, for instance, if we are using a single CRA, we use TransUnion.
You can get more information about each Credit reporting agency, as well as order your credit report to check your score and/or accuracy at these websites:

Types of Tradelines

Basically, a tradeline is simply an open line of credit. There are several different types, which we will discuss.

Usually the most common type of tradeline out there, it simply means that it is an open-ended line of credit. You can borrow money on it, pay it back, and then re-borrow without having to reapply for the tradeline. The most common revolving credit lines out there are credit cards, although some institutions do offer revolving lines of credit and other products. These types of tradelines usually have payments that increase or decrease according to the balance of the loan. These types of loans are generally frowned upon by potential borrowers.

This tradeline is a type of loan that you borrow $X on and pay it off over a set timeframe. An example of this type of loan would be a vehicle loan. These types of loans generally have fixed payments.

Basically, any type of loan using real property as collateral is considered to be a mortgage. These are typically installment loans, but there are other revolving products out there, such as lines of credit. These types of loans help your credit the most and damage your credit the least.

Obtaining Credit

Basically, it is usually very difficult to obtain credit when you have no credit history. The easiest ways to obtain credit would be either with a secured loan, secured credit card, or a co-signer.

Secured Loan/Secured Credit Card
Getting either a secured loan or credit card is probably the easiest way to get credit without help from others. Basically, with both a secured loan and a credit card the lending institution is lending money out to you because they have collateral. Collateral is something that is used to guarantee payment - common collateral are vehicles, homes, and funds. In most cases, these credit cards and loans will secured by funds - that is, cash you have in the bank. Generally, you will be required to deposit $X into an account with the institution. In this example, we'll use $500 as $X. Once your $500 dollars are in the account, they put a freeze on it - making it impossible for you to withdraw those funds until the account is closed or the funds are released. The institution will then issue you either a credit card or a secured loan, using those frozen funds as collateral.

If it is a credit card - secured or unsecured - never, ever charge over 50% of the credit limit, even if you pay the card off in full each month. The reasoning behind this is because potential lenders like to see that you still have funds available on your open lines of credit - that you are being responsible with it. The reasoning you can't ever do it is because the company that holds the credit card reports to the Credit Reporting Agencies (from now on known as CRAs for the sake of typing less) only once per month, effectively taking a "snapshot" of your current balances. If you are maxed out, even if the check to pay off the balance is in the mail, it will reflect poorly on you.

If it is a secured loan, although it may be tempting because it is costing you money to pay interest, don't pay it off early unless you have found a better alternative. Credit history is exactly that - history of your payments. The longer you have the loan, the better off you'll be in the long run. Look at the money you are paying in interest as an investment - maybe even the best you have ever made. With good credit, you will save tens of thousands of dollars in interest on big ticket items, such as a house.

To obtain either a secured credit card or a secured loan, I would suggest checking with your local banks or credit unions, and avoiding any cards with an annual fee. As long as you pay your balance off on full each month on credit cards, you do not have to pay any interest.

A cosigner is basically another individual put on the note ( loan) that is also responsible for payments. The cosigner is 100% responsible, they don't have any less responsibility than the actual borrower. If the payments are late or the loan defaults, the cosigners credit will be damaged just as much, if not more, than the borrowers. Using a cosigner will often allow you to obtain credit that you normally wouldn't be able to obtain without any other credit history. Lower interest rates, longer terms, or even just getting approved are some examples as to how cosigners can help. Having a cosigner on a note doesn't really matter as far as building credit goes, it will either increase or decrease as if you were on the debt alone.

Maintaining Credit

Basically, once you have obtained credit, maintaining it will be the key that will eventually unlock the "excellent" credit door. Time is both your friend and enemy - it will, after a number of years, erase any poor credit you may have, but it will also take a while to build good credit.

The key to maintaining and improving credit comes from six main factors. These factors are:
Payment History
Length of time accounts have been established
Keeping your balances below 50% of the limit
Having little unsecured debt
Having low outstanding balances
Number of Tradelines

We'll examine them a bit further

Payment History
This is by far and large the most important factor, and one of the biggest contributors to either helping or damaging your credit rating. Having a flawless or near flawless payment history is the best way to keep excellent credit. Payments are reported late only if they are 30+ days delinquent. Not that I would recommend it, but that means you could be 20 days late every month on your credit card payments and still have perfect payment history - although I would imagine you would be paying quite a sum in fees and interest.

Length of Time Accounts have been established
The longer accounts have been open, the better it will reflect on you. A credit history of 10+ years is very, very good.

Keeping your balances below 50% of the limit
This is important because the CRAs keep track of the highest balance you have ever carried on your revolving credit - aka credit cards or other revolving lines. Fortunately, however, if you were near or over your limit, the more time that passes the less it affects your score. If you recently went near/over your limit, a quick fix to this is to simply increase your credit limit and don't every go above your previous high balance.

Having little unsecured debt
The less unsecured debt you have the better off you are going to be. Unsecured debt is basically debt that you have that does not have any collateral attached to it - the most common unsecured debt is credit card debt, although there are other unsecured products out there.

Having low outstanding balances
Basically, this is regarding your total debt. Mortgages don't seem to have a whole lot of effect on this, but credit cards, vehicle loans, and other installments loans do play a role in this total. The less the debt, the better the credit

Number of Tradelines
The ideal situation is to only have 2-3 credit cards out there for unsecured debt, maybe a vehicle loan, and a mortgage. Believe it or not, you are actually penalized for not having any revolving credit lines out there - which would include credit cards. Many people have dozens of open accounts and never use them. There is absolutely no reason to have 10-15 or more credit lines open, even if you have no balances, the amount you could potentially borrow plays a role in calculating the score. Also, when closing accounts, make sure you actually contact the institution to close it, simply cutting them up and throwing them away isn't actually closing the account.

The Credit Score

Your credit score is simply a score assigned to you by the CRAs. They calculate your FICO score based on a variety of criteria, much of it is mysteriously shrouded. C'mon, you know everyone likes being graded on things where the rules aren't given to them, right?

Hopefully this will shed a little light on the topic...

Basically, the higher the score is, the more likely you are to repay your outstanding debts. By following this guide, you should attain a high score with relative ease - and keep it that way. However, there are a variety of little nuances that also affect it that many people are unaware of. For instance, applying for credit actually damages your score. If you often apply for credit and have a lower score than you feel you should, this is likely the reason. If you want to inquire about interest rates with several different companies, call them all on the same day. Several inquires lower your score far less if they are made the same day than those same inquiries spread over several days or several weeks. This is to allow the consumer to be able to shop around for rates and what not, without taking the full impact of applying at each place. Other factors include things I have mentioned above, and likely several others that I am unaware of.

Credit Myths and Legends

Paying extra payments/the account off faster helps your credit
False - Credit History is simply whether or not you make your payment on time or not. It doesn't actually show the amounts that you paid, simply whether or not it was on time - No more, no less.

It is good to have many accounts with no balances
False - Having many open accounts will actually reflect negatively on you. Potentially Lenders look not only at your current balances, but the actual amount you can borrow at any given time

A higher income will give you better credit
False - Nowhere does your income report to your bureau - it certainly will be a factor when trying to get approved, but doesn't actually help your score

Staying at the same Job Helps your Credit
True - If you are employed at the same place for more than 5 years, it will have a tremendous positive impact on your scores

Only older people have good credit
False - Young people can have good credit also, although admittedly, it is much harder to get your scores up due to the lack of activity

It only takes 2-3 months to get good credit when first starting out
False - It actually takes 6 months of continuous reporting before you even get a score, most lenders won't touch someone who does not have a score without a cosigner

Being an authorized user on someones card helps your credit
True - Usually, it will report to the bureau exactly like a card on your name - although of course, it will not be helpful if the person is near the limit or late on payment

It's ok to charge up to the maximum limit on credit cards as long as you pay it off each month
False, see above where I explain how the reporting works - the "snapshot" of your credit doesn't necessarily reflect if it is paid in full each month or not.

Fran Bourassa

Well - if anyone can find any groups that would do more good than harm in the credit realm for the ipoint community, drop me a line and let's see if we can't create a synergy.


No comments: