Credit Score

All the time I hear people talk about their credit score. And everyone who is hoping to buy a house seems to have found a way to unearth the three-digit number that they claim is “their score”. I say I am always skeptical of the numbers they offer up—because one set of credit score numbers from one source can be different from the numbers from another source—for the same person. Credit score numbers are based on formulae and algorithms, and in my mind are based on five parts history and five parts of sorcery. This seemingly harmless number is strongly tied to the amount you can borrow. It influences the terms you will be offered. In order to stay on top of your finances, it is crucial for an individual to thoroughly understand credit scoring in order to make well-informed decisions. There are three main credit bureaus, Equifax, Trans Union and Experian. While each credit bureau uses a different method for calculating your credit score, individuals with a long history of paying their debts on time, using the appropriate types of credit and not exceeding their available credit lines are most likely to have a good credit score. The higher your credit score, the higher are your chances of securing a loan with desirable terms. Put yourself in the position of a lender, if you were considering lending money to someone you didn’t know, wouldn’t you would want to try to figure your chances of getting your money back, with interest, and on time? If you had Tony Soprano to help you collect the debt, maybe you wouldn’t mind a higher risk, but for a mortgage for a home—banks and other lenders live with your credit score as created by one or more of the three main credit bureaus. Since payment history is a clear reflection of an individual's likelihood of defaulting on financial obligations, your credit history is the biggest contributor in a credit score calculation. As the highest contributor to your score, individuals with a habit of paying bills late are most likely to suffer. Payment history is about 35% of your credit score. The next biggest contributor to your credit score is credit utilization, sometimes called outstanding debt. If your debts are close to your credit limit, your score will take a steep decline. Similarly, if you have outstanding balance on several accounts—let’s say several credit cards—expect that to count against you. Outstanding debt makes up 30% of your score. The next most crucial aspect of your credit score is the length of credit history. They say old credit is the best credit. This is indeed true because the longer your accounts are open, the better it is for your score. Credit history has a 15% contribution to the credit score. Your debts are your friends only if they are well managed. It’s better if they have been in place for years. Clients who always pay cash for everything—thinking that having no debt is better for their credit score--are often advised to borrow some money from a well-known bank. They should take a personal loan (which is generally a short term loan and unsecured) or an auto loan (if they already have a car that’s all paid for, consider refinancing the car). Accepting debt will demonstrate your willingness and ability to handle these loans, as long as you make your payments on time and in full. The last 20% of your credit score is partly based on the kind of debt you have, the more debt and the more appropriate the types of credit you have (and can manage in a timely manner), the better. Finance company accounts, retail accounts, instalment loans, and credit cards accounts are the ideal mix of accounts. And your recent activity rounds out the report. Meaning that if three or four loan companies have recently “pulled your credit”, this will lower your score. If you decide you want a mortgage, before you get started, spend some time with a lender and discuss your credit. Then, when you apply for a mortgage, you will actually have some credit, and they will see that you are someone able to manage debt. Dane Hahn is a real estate professional affiliated with Sarasota Realty Associates in Venice--serving both Sarasota and Charlotte Counties. You can reach him at dane.hahn@gamil.com or by phone at 941-681-0312. See him on the web at www.danesellsflorida.com