Best Results Organizing

If you’ve ever bought a car or house, you probably know all about your FICO score. If not, you might wonder what the big deal is. The bottom line is that the better your FICO score, the better interest rates you can get on loans.

Let’s say you want to take out a 30-year fixed mortgage of $250,000. Someone with the highest FICO score (760-850) could get an interest rate of 4.99%, for a monthly payment of $1341; skip down a few rungs on the FICO ladder to the 620-639 range, and the rate would be 6.58% with a monthly payment of $1594. That’s a difference of $91,080 over the course of the loan!

Oh, but you’re not going to buy a $250,000 house? What about a car–a sensible $15,000 car? Someone with a top-flight FICO score, maybe 810, will pay 6.36% on a 36-month car loan…that’s $459/month, but a lower-to-middle-tier scorer (say 620) would end up with a rate of 12.76% and pay $504/month. That $1620 difference comes out of (or stays in) your pocket, depending on your FICO score.

So what is FICO?  A credit score, in general, is a number that represents creditworthiness — the statistical likelihood that someone will pay his or her debts. The score purports to predict risk, and financial institutions use it to determine how much interest they’ll charge to let you use their money. It’s kind of like how the insurance tables predict that it’s less statistically likely that a 55 year-old-grandma will be hot-rodding around town vs. a 16 year-old football star, and thus charge car insurance rates accordingly.

FICO stands for the Fair Isaac Corporation, the company that developed the fancy math behind the scoring system using data from the major credit bureaus (Experian, Equifax and TransUnion). FICO scores range from 300-850, and while there are other credit scores, including the VantageScore and the NextGen score, FICO is the most widely used by U.S. lenders.

I know some people out there will email me about the evils of credit card use. If I were a consumer reporter, I could fill up multiple weekly columns on the downside of the industry, but it’s rarely possible to live in our modern world on a cash basis. If you want to buy a home or even rent a car, you have to have a credit history. It’s impractical to purchase a house in cash (and it’s likely the IRS and FBI might show up the same day as the moving men, if you tried).

Obviously, we shouldn’t purchase what we can’t afford, but there are a variety of circumstances (ranging from medical procedures that must be pre-paid to business expenses that won’t be reimbursed for a few weeks) that encourage even the most frugal person to use credit. And of course, some people find the added consumer protection of a credit card to be an essential form of insurance against the vagaries and whims of big business.

So, let’s assume, for the sake of happy blogging, that we’re all responsible users of credit, and that we’re all doing what we can to avoid any interest charges or fees. Given that, what can you do to make your FICO as fabulous as possible?

Knowing how your FICO score is calculated is pretty much theoretical until you know your own data. Go grab all the paper on your plastic!

Pull the folder for each of your credit card accounts from the financial section of your Family Filing system. Look at the most recent statement from each card issuer and note the following:

–The percentage interest rate
–The date due
–The credit limit

Now, let’s look at the make-up of the FICO score.

35%  =  Payment History

Pay your bills on time. Seriously. If you do nothing else to keep your FICO score in line, do this. Plus, in 2006, the Government Accountability Office reported that credit card late payment fees were up to an average of $39. (Big surprise, those fees haven’t receded.) Pay one bill late per month, that’s $468/year!

Flip through the last half dozen statements to see when your payment date was. Is it always the same day of the month or does it vary? Credit card and loan companies seem to thrive on the idea that you’ll assume a due date will always stay the same, that you won’t read the due date (or the small print notifying you of a change of date) and that you’ll pay your card at the last possible minute.  Don’t let them win.  Instead:

• Show up for mail call. Open the mail the day it arrives, toss out the glossy advertising inserts, and if you pay online, toss the envelopes, too.
• Read the statement ASAP and check for new policies and/or errors.
• Circle or highlight the payment due date. Write it on your calendar. Set alarms on your computer.
• If the due date is inconvenient, ask your lender or card issuer to change the date to a more convenient one; most companies (even utilities) are willing to do so.
• Put your bills in one place, in your bill-paying center, and arrange them in chronological order, by due date. Alternatively, use a tickler file and put the bills in slots at least 7 days in advance.
• If you use online bill-pay, consider scheduling payments the day you receive your bills (no matter what date you actually choose for assigned payment). Bank of America, for example, lets you select the date you want the payee to receive the money, and guarantees the transaction. Other banks schedule by when the check or electronic payment is sent; if the payee requires a tangible check, that can lead to delays, so know how your online bill-pay system works.
• If you snail-mail your bills, note the fine print on your credit card statements.  Some say payments must be received by 1 p.m., or 12 p.m. or even 9 a.m. or will be posted the next day. You’ll need to mail the checks at least seven days before they’re due, and even then, you are dependent upon the Post Office.

You already know that you should pay your bills in full. Failing that, you certainly know that if you only pay the minimum, you’ll not only never keep pace with the interest rates charged, but will be old and grey by the time you’ve paid off that Jonas Brothers MP3 download. But whatever you pay, pay on time to keep your FICO, and your finances, healthy.

30%  =  Credit Utilization (How much you owe vs. how much you could owe)

It’s not just a matter of how much you owe, but the ratio of how much you owe (in revolving, or credit card, debt) to your credit limit.  You and the person reading this blog over your shoulder may very well each owe $500 in credit card debt. However, if your credit limit is $10,000, your utilization is only five percent; if the person over your shoulder has a credit limit of only $1000, he or she is utilizing 50%.

Financial experts vary on the utilization limits they suggest. Before the current recession started, for example, Business Week advised no higher than 50%, but experts are being more circumspect now, suggesting a utilization of no more than 30%, and preferably 20%.

So how can you be sure you’re doing that?  Divide the amount you owe by the credit limit; unless you’re a math whiz, use a calculator. Then move the decimal point two spaces to the right (remember that from math class?) and that’s your percentage utilization. Higher than 30%? Start whittling it down. When you find a $10 bill in a coat pocket, or your Aunt Tillie sends you an unexpected birthday check, snowball that money towards debt, ostensibly until it’s paid off, but certainly until your utilization number comes down.

So is 0% utilization best? Sorry, nope.

First, if you’re not using it, the credit agencies have no way of gauging how well you can handle credit. It’s like dating; if your blind date is 43 and this is the first date he/she has ever been on (and there’s no monastery or convent listed as a prior address), the lack of experience is going to ring some alarm bells. Plus, many store cards close accounts if you don’t use the card in a 12-month period, and major credit cards are frequently canceling cards due to lack of use.

And what happens when cards are canceled? Your total credit limit decreases, thereby increasing your overall utilization. Then your average length of credit history (see below) is also reduced–ouch!

Paper Doll isn’t advising you to live beyond your means. However, you may want to rotate the cards you use and buy something (that you were going to buy anyway) to keep each card active. If this gives you the jitters, there’s no reason you can’t go home and immediately transfer money in the amount of your purchase to your credit card company via online bill pay. Talk about short-term debt!

15%  =  Length of Credit History

Obviously, you can’t always have control over all aspects of this category. If you’re 22, have had one credit card for about three minutes, and have never had a car, student or other type of bank loan, a lower score in this category is to be understood. As you age and responsibly use the credit you obtain, this area will improve, until your credit history has reached its maximum potential, usually at a 40-year credit history. So, if you got your first credit card as a college freshman, once you hit about 58 years of age, you’ll probably max.

10%  =  New Credit

“Do you have a NiftyStore Card?  If you open an account today, you’ll get 10% off this purchase.”

Don’t do it!

Applying for and opening new lines of credit, whether to get a discounted purchase, 0% balance transfers, free miles, or a cash bonus for signing up, can ding your FICO score in a few ways. First, obtaining lots of new credit lines shortens your average length of credit history. Plus, if you apply for lots of credit in a short period of time, you may seem like a credit risk because if you have so much more available credit open to you, you might run wild. (Yes, this does seem like an opposing argument to the utilization issue of having lots of credit but using only a small amount. Isn’t FICO fun?)

Three or more credit application/inquiries in the course of a 30-60 day period is going to have a small hit on your score. It’s not huge, but it makes sense to apply for credit in a sensible way, once you’ve researched the options, and not spontaneously, to get $3 off a sparkly T-shirt.

It might be a comfort to know that credit inquiries for car or home loans over a short period do not adversely impact your FICO score the way applications for revolving credit will, so it’s OK to check different lenders to get the best mortgage rates.

10%  =  Types of Credit

The credit industry likes to see that you have the ability to handle many different types of “good” credit. Rather than just revolving (i.e., credit card) debt, they also like to see installment loan (like mortgages and auto loans) history. Points are often lost if you have finance company loans, not only because they tend to have significantly higher interest rates, but because finance companies are often considered last-chance lenders and because financed purchases are often leveraged against second mortgages or home equity.

See? Out of 100%, not even 1% of your FICO score is determined by how fabulous those shoes you bought on sale were.

Given all this, you can see why it’s important to keep on top of the paper representing your plastic:

Be responsible with your payments. Read statements carefully–check due dates and make sure you’re not utilizing too much of your available credit. Pay bills on time, or preferably early, and scrutinize statements to make sure all payments have been properly credited. Call to correct errors quickly.

Obtain and monitor your credit credit reports by using AnnualCreditReport.com to verify the accuracy of information and to make sure you’re not the victim of any FICO-shredding identity theft. (Avoid imitators like the “free” credit guys, the ones with the great commercial jingles and pirate hats.) One report from each reporting bureau is free, but expect to pay about $8 for your FICO score.

Pursue new lines of credit thoughtfully. Research the best interest rates available at sites like BankRate.com or Nerdwallet.com.

Organize your financial records so that you can always check your revolving credit or installment loan agreements and payment history quickly and easily.