6/13/2013 6:00:00 PM PRACTICAL SAVER Take steps to improve your credit score: Part II
KARA ROZENDAAL Courier Columnist
Last week's column focused on how consumers can find out about their FICO score, which is the score that banks use to determine the type of credit they are willing to lend. The score is comprised of several weighted factors: 35 percent - payment history; 30 percent - amounts owed; 15 percent - length of credit history; 10 percent - new credit; and 10 percent - types of credit used. Factors that don't affect the score are age, race, occupation, location of residence, and whether or not credit counseling has been enlisted. Below are some practical changes consumers can implement to improve their score and overall financial picture.
Before we begin, we should discuss the statistics on how people with excellent scores are managing their credit. Among this group, 93 percent have not missed any payments at all and have an average age of accounts between 6 and 12 years. Many have accounts that have been opened for 19+ years.
With that said, let's focus on how an average person can improve their own score to fit these statistics. One factor that will impact a person's credit rating is the number of "hard inquiries" made to credit reporting agencies. Each time a credit card application is completed, a bank obtains a copy of the credit report to assess the financial picture of the individual. This type of inquiry is called a "hard inquiry" and will be noted on the credit report so that other lenders know that an application was recently submitted. The "hard inquiry" can deduct up to five points from the FICO score. If several separate applications are made within a two to three month period, the score will decrease even more. Lenders equate searching for new credit with higher risk. Inquiries from multiple auto or mortgage lenders within a short period of time, however, are typically treated as a single inquiry and will have little impact on the credit score. A "soft" inquiry on the other hand, is one that the consumer initiates to check the accuracy and health of the credit report. This type of inquiry does not affect the credit score. To improve the credit score, it is important for consumers to resist applying for credit and thereby decreasing the amount of "hard" credit inquiries.
Another area to carefully examine is what to do with old credit cards that are not being used. It may seem wise to close credit accounts when they are not in use or no longer needed, however, be careful. Closing accounts can actually have a negative impact on the credit rating. When an account is closed, the account history (length of credit) is removed from the credit report. So, open accounts can be a positive attribute. However, this is only true when there is a modest amount of available credit being used responsibly and prompt payments are being made. Open accounts have a negative impact when there are numerous credit cards with high credit limits and the balances are near the limit or maxed out. The impact is even worse when payments are not made on time.
If a person finds themselves in a financial setback such as bankruptcy, it is imperative to establish credit in order to prove payment responsibility. It may be difficult to find a lender who will issue credit, and it might be necessary to find one that specializes in high-risk borrowers. In order to establish credit, it is necessary to charge one or two items a month and pay off the balance each month. This will help improve the FICO score by building a long credit history, a positive ratio of account balance to credit limits, as well as having on-time payments.
The health of a FICO score is vital to a prosperous financial future. The good news is that a poor credit score will not hang around forever if the effort is put in to raise the score. To improve the overall score, focus on keeping a good payment history with no late payments, maintaining the overall debt as low as possible, building a long credit history and minimizing the amount of new credit. All of these factors combined will assist in making a happy FICO score.
Kara Rozendaal, a financial planner, wife and homeschool mother of three, has lived in Prescott Valley for 16 years. Kara's website www.PracticalSaver.com helps make shopping simple and savings possible.