Credit, what is it, why is it so bad, why is it so great!

Credit, what is it, why is it so bad, why is it so great!
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March 9, 2007 at 12:46:21 PM
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I think there are many many common mistakes out there when it comes to credit, and it seems like even the most educated people make those mistakes. As of late, I have had a lot of clients and new applications from people that are making the same common mistakes, and I think it is important to find out where your "FICO" score comes from, and why it is the most important thing when it comes to real estate and investment financing.
First things first, FICO is a formula, I don't have it, no one in the public has it, but the glorious people at the Fair Isaac company, the people that formulate the FICO score, do. What I am offering for information here is purely what I have read, and experienced. If you want the true numbers of where the score is derived, go to www.myfico. com.
The most common misconception is that once you have paid off all of your credit cards you should cut them up, and close the accounts. Well one part of that is true, cut them up so that the next time you walk into Sears and see that shiny stainless steel BBQ with side burner, you won't have access to the credit card if you don't have cash or debit. The reality is that one of the major factors of your score is your history. Let's take an example, if you have had your VISA card for ten years, never had a late payment, don't have a balance, and then you close the account, you lose that 10 years of history. History makes up 15% of your score. Cutting up the card will have a positive effect on how you spend money, but closing the account will have a negative effect on how your score performs.
The biggest effect on your score if your payment history. Make payments within the first 30 days of their due date is the most important, even if you are just making the minimum payment. 30 day late payments are the most important on mortgage payments. Auto payments and credit card or installment payments are important, but mortgage payments are the most important, because as a lender, a mortgage late almost always puts you into a subprime or more alternative financing situation.
The next most significant factor is the balances of your credit. The best way to think about Credit Cards, is to always try to keep your balances below 35% of the credit limit for the card. For instance, if your limit is $10,000, try to keep the balance below $3500 to avoid having a negative effect on your score. Some people believe that it would be better to max out one credit card, and have the others with 0 balances. The fact of the matter is that you would be better off spreading out the debt amongst all of your cards, and try to keep the balances on all of them below 35%.
New Credit! Applying for new credit can have a negative effect on your score and the type of account you are applying for can effect your score. Opening discount accounts, or accounts with teasers (no interest for 12 months) can have a negative effect on your score. I know when you are at Sears about to get that new plasma screen and the salesperson offers you 12 months free financing, and you think, "hmmm, should I keep the money in the bank, or let Sears pay for it over the next 12 months." I have wrestled with this type of decision myself, not for a plasma, but for a washer and dryer. From a credit decision, the decision should ride on your short term goals with credit. Are you buying a car or home in the near future? Maybe paying cash would be a better option, because applying for that new credit MAY, and I stress MAY, have an effect on your score and even your debt to income ratio. How did I make the decision? I went with getting the Sears offered financing because I could keep the money in the bank, and pay for it over the year, only because I wasn't making any large important credit based purchases in the near future. ****MAJOR NOTE FOR PEOPLE BUYING A HOME*****As a mortgage broker, the most important advice to you is, if you are in excrow on a purchase, do not, and I say again, do not, buy anything with credit, until that loan is closed. For two reasons, the lender can repull your credit and if that new account shows up and your score drops and takes you out of that loan that you have been "approved" for, you may have issues. Wait a few days, and buy the cabinets with credit when the loan is closed. You may laugh and say it doesn't happen, but believe me, it does!
Another major factor is the time frame the credit report shows something as occuring. Things that have happended recently, will have a larger effect on your credit. For instance a late payment that happended last month, has more of an effect than a late payment that happened 2 years ago. The rules I follow are, that first 6 months have the largest effect, the next 6 months since that late payment will have less of an effect, the next 12 months will have even less of an effect, and the following 12 months from that, will have little effect. The thought behind this is that if your are missing a payment today, you may be having financial issues, therefore, you are a higher risk, and should have a lower score. A tip for old collections and things that are over 12 months old. It may be in your best interest to NOT correct those accounts. The reason is, if you update or correct things that are old, they will have a "last updated" date of today. This makes it a current collection or late payment. We want to let old issues stay where they are, in the past!
With the news on how the subprime market is changing daily, credit is the most important factor in real estate finance right now. Income, and being able to document it is a factor, but that first and most important factor is credit. If there are negative items on your credit report that are not correct, removing them from your report is possible, it will just take some effort to call the credit company and resolve it.

For more about my services and to chat if I am online, please visit www.jonathanvettermortgage.com

Tags: Credit, finance, subprime, credit cards, FICO, Debt