The Fico score is designed to tell the creditors the potential of you having a 90 day late in the next 24 months. How the score is calculated is based upon the following:

35%        of your score is based on your Payment History

30%        of your score is based on your Balances

15%        is based on your Credit History

10%        is based on the TYPE of Credit accounts you have

10%        Number of Inquiries within a specific time

 

Explanation of each category:

10% Inquiries – They stay reported for 12 months, after that they are disregarded. FICO like to only see 5-7 inquiries per year. There are different kinds of Inquiries….Mortgage, Auto, Revolving & Installments. Having your credit run for a mortgage by different companies does not really hurt your score.

If FICO shows you have many revolving “Master Card, Visa, Store Credit” Inquiries, Creditors see it as you are in need of money and may be in financial problems. This may wdrop your score.

 

10% Type of Credit – You get a drop in your score if you open a “Buy now Pay later account” such as from a furniture store. It is researched that people with these types of accounts have or will at one point in time, a 90 day late payment. This is due to the fact that they may have a job at the time the account was opened, but things happen financially where employment is lost and when it is time to pay….they can’t. Thus the late payment. If you already have one of these types of accounts, you may pay it off, BUT NEVER CLOSE THE ACCOUNT! Just don’t use it anymore

 

15% Credit History – In a PERFECT world, creditors want to see a 30 yr credit history. If you have had a MC for 20 years and you open a Visa account after those 20 years, your credit history gets cut in half. You now have a 10 year credit history. Every time you open a new account, your history gets cut in half. The reasoning behind this is due to the new account you have opened, you have no history with that new account.

Typically 3-5 revolving accounts are sufficient to score well.

 

30% Balances – Number one rule….NEVER CLOSE AN ACCOUNT!! This can drop your score as much as 100 points. Rule of thumb for balances on accounts are 75% & 50% of credit limit. Ideal is 35% of credit limit. If you have 5 cards and they all have a $1000 credit limit, and one of them is at its limit, it will drop your score. NOW, if you were to take the card that is maxed out and spread the balance out between the other 4 cards with balances of $200 each, you will get a bump up in your score. They are each below 75%, 50% & 35% of their credit limits. This shows good money management of your accounts.

If you know you have paid down or paid off a balance and it doesn’t show on your report, get a letter from the creditor on their letterhead saying it is paid off. You can take this letter and use it to do a rescore to get your FICO score up.

 

35% Payment History – Recent’s…..how many account you have opened or applied for in recent time.

Frequency…..how often any late payments have occurred.

Severity…..how sever any of the late payments were, 30-60-90 days. Most damaging is any late within 0-6 months. They are less damaging 7- 23 months, and even less 24+ months on.

Collections – DO NOT EVER PAY OFF COLLECTIONS UNLESS  the creditor agrees to give you a deletion letter. This will delete the account from your report.

If you have a collection from year 2000, and you pay it off in full without a deletion letter in year 2005, the collection will be reported right then and there and show 2005 (current) which will ding your score significantly, as much as 100 points. If the creditor or collection agency Customer Representative does not want to give you a deletion letter, Ask to speak to a Supervisor and request it from him. If the supervisor still does not want to give the deletion letter, then pay the collection out of escrow, this way it will be documented and verified by the Mortgage Lender (Banks).

A collection account can only be reported for 7 years and 1 month from the date of last activity. BUT what happens from time to time is the collection account from year 2000 is sold in year 2002, and so it continues to report for 7 years from the date sold. This is why the deletion letter is required to clean from your report.

Medical Collection** One thing you can do is DISPUTE the collection with the credit bureau. Once disputed, it will not count in the calculation of the score. 

 

Home Equity Lines of Credit – This type of account shows as a revolving credit account in which it affects your score for it will be calculated under the 70% & 50% Rule. BUT if the credit line or limit is over $25,000 it will be treated as an installment account which would calculate at a better score than a revolving account will.

 

Judgments & Tax Liens – If you have had a judgment or tax lien and you have paid it off and it still shows on your report, you can have these removed as long as you have an official Court Stamped Document showing it paid.

 

 

**You will get a small bump in your score if you have a very small balance on your accounts rather than have it at zero. Not using your accounts may cause the creditor to close due to inactivity. YOU DO NOT WANT YOUR ACCOUNTS CLOSED!!

 

American Express – Typically there is no preset limit on this account due to it needs to be paid at the end of the month every month, so having this account may not improve your score. A creditor may accept the highest amount charged in one month as the limit.

 

**** Make sure all your accounts are reporting their limits to your report.

 

Bankruptcy – Ever wonder why one person with a bankruptcy has a 580 Fico and another person with a bankruptcy has a 620?

Someone who claims 100% of all accounts in their Bankruptcy will end up in the 580’s or less Fico. Someone who only claims 80% of their accounts in their Bankruptcy will end up with a better score, usually in the 600’s.

The reason for this is one still continues to have accounts open and usable. Someone with a recent Bankruptcy will have difficulty opening new credit accounts, where as someone who only claims 80% can use their remaining open accounts in rebuilding credit history Immediately.

Typically Creditors would like to see 24 month (2 years ) period from date of discharge, of credit rebuilding history, before allowing credit to be extended to the applicant.

 

So in conclusion, if you need to file for Bankruptcy, Only Claim 80% of accounts if permissible and continue working your credit history without any further late payments for the next 24 months.

Co-Signing for other people or family members:    It is very kind of you to help a friend or family member out by cosigning for a car for them, a house, credit cards or revolving accounts. The one thing most people do not know is that when you co-sign for someone, you are also liable for that account, therefore you are liable for the debt even though that person is making the payments. The bank extended credit to the person with credit history because you, the friend with good credit history, cosigned for him agreeing that if he fails to fulfill the contract……You Will. READ THE CONTRACT. If your friend or family member defaults, per the contract, you are liable to fulfill the contract. If you do not continue to pay the installment per the contractual agreement, it will be reported on your credit history and effect your credit score.

 

By cosigning for the account it will also show up and be calculated in your Fico Score. This in turn will affect your Debt to Income Ratio. Your Debt to Income Ration, is calculated by dividing your total monthly debt (credit cards, car payment, installments) by your gross monthly income. Please see the following example:

 

Car Payment: $600                                          Construction Worker                      Monthly Income

Credit Cards: $350                                            $25 per hour                                                      $4333

Furniture Installment: $150                         40 Work Week                                 

Total Liabilities: $1100

 

Debt to Income Ratio: $1100 divided by $4333 = 25% Debt to Income Ratio

 

Now see what happens when you cosign for a friend or family member:

 

Brothers Car

You cosign for: $500

Sisters Furniture you

Cosign for: $300

Car Payment: $600                                          Construction Worker                      Monthly Income

Credit Cards: $350                                            $25 per hour                                                      $4333

Furniture Installment: $150                         40 Work Week                                 

Total Liabilities: $1900

 

Debt to Income Ratio: $1900 divided by $4333 = 44% Debt to Income Ratio

 

As you can see, even though you do not make the payments on those accounts, they are on your credit report and will affect your calculated Fico Score. So in conclusion, the more liabilities you have, the higher your Debt to Income Ratio.

 

Prequalification For A Home Loan: For a Bank to grant you a home loan, every applicant must meet their Debt to Income Ratio for any certain loan program they have. This is a guideline used by all banks. For someone with excellent credit, and a Debt to Income Ratio of 28%-36% will get a better Interest rate than someone with the same credit score but with a Debt to Income Ratio of 36%-45%. In today’s Real Estate Market, Banks have changed certain guidelines to allow lower income families to qualify for a home loan. There are some banks that will allow Ratio’s from 45% to 55%.