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How To Perfect Your Credit Score
How to Perfect Your Credit Score
Finance | By: Annamaria Andriotis |
Olympic divers and college-bound test-takers have a valuable lesson to teach U.S. borrowers: Getting a higher score can really pay off.
Lenders make well over $1 trillion in loans every year based in large part on credit scores developed by Fair Isaac Corp., a firm based in San Jose, Calif., that attempts to quantify which borrowers are most likely to repay the money on time. Borrowers with higher FICO scores are generally eligible to get bigger loans at lower interest rates.
But turning a good score into a great one can win you an even lower interest rate, and save thousands—even tens of thousands—of dollars for borrowers who take out a mortgage, buy a new car and use credit cards, experts say. In addition, consumers with sterling credit often have their pick of lenders and can sometimes use that leverage to pay lower loan fees.
Tens of millions of Americans carry credit scores that are just under the highest range. Some 32.8 million people have FICO scores between 700 and 749, on a scale of 300 to 850, and another roughly 36.4 million people have scores between 750 and 799. About 38.6 million are in the 800-to-850 range. Roughly 1% of the people with FICO scores, or around 2 million individuals, have a perfect 850.
Most lenders consider people with FICO scores of at least 720 to be prime borrowers, and generally charge them interest rates that are low—but not the lowest available.
When the best deals kick in can vary by lender and type of loan. But the benefits can be substantial.
For example, home buyers with FICO scores between 700 and 759 could get an interest rate of 3.983% on average on a $400,000, 30-year fixed-rate mortgage with a 25% down payment, as of Jan. 6, according to Informa Research Services, a market-research company based in Calabasas, Calif.
Home buyers with FICO scores in the 760 to 850 range could get an interest rate of 3.821% on average under the same circumstances, which means they would pay $6,194 less in interest in the first 10 years and $13,366 less over the life of the loan. On “jumbo” mortgages, which are common in pricier real-estate markets, the savings could be greater.
Borrowers who want to boost their scores can take certain steps that will pay off within a month or two, and others that will raise their scores over many months or even years.
Here’s how to make your score stand out to lenders.
How FICO Scores Work
The first step is to understand how FICO scores are calculated—and the role your score plays in lending decisions.
Five factors go into a FICO score. The most important is your payment history, which accounts for 35% of the score. If you want a high score, the first piece of advice is the simplest: Pay your debts on time.
The second factor is the overall amount of money you owe—including how close you are to the limits on your credit cards—which accounts for 30% of the score.
Another 15% of the score depends on the extent of your credit history, which favors borrowers with a long track record, while 10% is determined by whether you have shown an ability to manage different types of credit. The remaining 10% depends on whether you have applied for credit recently.
The three main credit-reporting firms—Equifax, Experian and TransUnion—then plug the information they have in your credit reports into the score calculation. The information each firm has may differ, so your scores from the three firms may vary.
Cody Goebel, who is 51 years old and lives in Silver Spring, Md., says he found out in late December that his FICO scores were 795, 806 and 807 when he applied to refinance his mortgage.
“I just try to manage my finances carefully,” says Mr. Goebel, a financial-markets policy analyst. He maintains a variety of loans, including credit cards, mortgages and private student loans he has cosigned for his two sons. And he regularly checks his credit reports to make sure there are no errors or fraudulent accounts that have been opened in his name—a problem he encountered about a decade ago.
Checking scores is getting easier. FICO has reached deals with a growing number of lenders to show their customers whichever of the FICO scores the firms use in lending decisions, at no charge.
Later this month, for example, Citigroup will begin showing customers who have Citi-branded credit cards their FICO scores. Lenders who already provide the service includeDiscover Financial Services and Barclaycard, a unit of Barclays.
Consumers in such programs also can see brief descriptions of what is holding their score down. In some cases, they can see when their score went up or down.
It also is possible to get access to your FICO score by paying a fee. Experian began offering that service in December, and Equifax already does, as does FICO through its consumer website, myFICO.com.
Prices vary by company and can range from $14.95 to $21.95 a month, and often include related services. For example, Experian also lets customers run scenarios which show how their scores might change if they pay down credit-card debt or take other similar steps.
Several firms run ads saying that they sell or give consumers credit scores free. But many don’t provide FICO scores, instead offering ones that are rarely, if ever, used by lenders. The scores can be significantly different from their FICO score, which can catch consumers off guard when they apply for a loan and find out they aren’t as creditworthy as they thought they were.
Keep in mind that the FICO score isn’t the only factor lenders consider when deciding whether to offer you a loan or what interest rate to charge. The size of a down payment or the extent of your relationship with a lender also can play an important role. Many lenders also have their own proprietary credit scores.
A Quick Payoff
Two fast ways to boost your FICO score are to spend less on your credit cards and to pay off card balances. In some cases, those moves can help raise a borrower’s score within as little as a month, says Ethan Dornhelm, principal scientist at Fair Isaac, also known as FICO.
If you want a FICO score of 800 or above, you should aim for a “debt-to-limit ratio” of no more than 10%, says John Ulzheimer, president of consumer education at CreditSesame.com, a credit-management site, and a former FICO manager. For example, if your total spending limit on all credit cards is $50,000, try to use no more than $5,000 at any one time.
The FICO formula also penalizes individuals who have too many credit cards with balances, Mr. Ulzheimer says. Instead, consider using no more than two credit cards and choosing the ones with the highest spending limits, he says.
Paying your credit-card bill in full when the statement arrives isn’t good enough if you want to keep your debt-to-limit ratio low, as the balances on your credit reports at Equifax, Experian and TransUnion are based on the most recent month’s credit-card statements, Mr. Ulzheimer says.
One trick: Pay the lender soon after you use the credit card, well before the statement closing date. Online payments often are processed in one to three days.
“I’ve been putting all my purchases [when] possible on credit cards and paying them off every week,” says Andrew Colucci, 29, a doctor in Boston. “I’m paid weekly, so when there’s a direct deposit I just send the payment.”
Mr. Colucci says his FICO score, which was 791 last summer, helped him to refinance approximately $120,000 of federal student loans at fixed rates as high as 6.8% into a private student loan at a 2.63% variable interest rate with Darien Rowayton Bank in Darien, Conn., in August.
Know Your Limits
As for increasing your spending limits, pay attention to the pitches you receive from card issuers. More issuers have been telling existing cardholders they are eligible for increases in the past year or two, says Curtis Arnold, founder of CardRatings.com, a credit-card comparison website.
But if you want to boost your FICO score, don’t use that extra credit. Also ask the card company if it would make a formal request to check your credit report before approving the increase; that alone could lower your score, Mr. Ulzheimer says.
Beware of store credit cards, which tend to come with relatively low spending limits. Consider using charge cards, such as those issued by American Express, as their balances often aren’t included in the credit-card debt-to-limit ratio in certain FICO scores that lenders use, says Mr. Dornhelm of FICO. Most charge cards don’t have a spending limit, since cardholders must pay the bill in full each month.
Consumers can check how issuers report charge-card activity on their credit reports, which they can access free once every 12 months at AnnualCreditReport.com.
Lastly, try to use each credit card you have at least once a year, says Mr. Ulzheimer. Card issuers sometimes shut down unused cards, which can hurt your score.
Take the Long View
Other strategies can take months or years to boost your score, which is worth keeping in mind if you are planning to make a major purchase such as a house or a car down the road.
Building a credit history and demonstrating an ability to manage different types of debt—such as credit cards, car loans and mortgages—both take time.
The good news is that if you manage debt responsibly, your FICO score should increase and the benefit should endure for years. When borrowers successfully pay off car loans or mortgages, the information stays on their credit reports for 10 years from the date of the last payment, according to credit-reporting firms.
There is an important exception: If you miss payments or default on a loan, that information stays on your credit report for seven years. So if you encountered financial difficulties during the financial crisis, say, waiting a little bit longer before taking out a new loan could be worthwhile.
The impact of missed payments is usually worst in the first few years, but 96% of people with a FICO score of 785 or greater have no late payments on their credit reports, according to FICO.
Time your loan applications wisely, as well. Consumers should look for the lowest interest rates on mortgages, car loans and student loans. Shop quickly: Such credit inquiries aren’t factored into your FICO score within their first 30 days on file. They can affect the score after that period but are treated as one inquiry if they occur within a 45-day window.
If you take more time, the inquiries could count as multiple requests, which can lower your score, Mr. Ulzheimer says.
Inquiries can stay on your credit reports for 24 months, he says, though the FICO score factors in only inquiries up to 12 months old.
Once you boost your FICO score, make the most of it. Some lenders don’t draw a distinction between a borrower with a score of 740 and a score in the 800s.
Find lenders that do. The payoff may come in the form of lower interest rates or lower fees. For borrowers who are seeking a $1 million mortgage with a 25% down payment and who have a FICO score in the 740 to 759 range, Salt Lake City-based Zions Bank, a unit of Zions Bancorp, has recently been charging an origination fee equal to 1.375% of the loan amount, or $13,750, and charging an interest rate of 3.625%, says Jeremy Lowry, a senior vice president at the bank.
Borrowers with a FICO score of 760 or more pay a 1% origination fee on the same loan.
Car buyers can benefit handsomely, as well. A car buyer with a FICO score of 730 would get an interest rate of 6.837% on average on a five-year loan to buy a new car, as of Jan. 6, according to Informa.
But borrowers with a FICO score of 800 could get such a loan with an interest rate of 3.24% at Birmingham, Ala.-based Regions Bank, according to Informa. That would result in $2,750 less interest on a loan of $27,799, the average amount for new-car loans in last year’s third quarter, according to Experian.
The larger the loan, the bigger the potential payoff. Cincinnati-based Fifth Third Bancorp, for example, sometimes offers lower interest rates to borrowers with FICO scores over 800 than to borrowers with FICO scores from 760 to 800 for jumbo mortgages—home loans that exceed $417,000 in most of the country, or $625,500 in pricier markets such as New York and San Francisco, according to Informa.
This story was originally published Jan. 9, 2015, on WSJ.com. via Realtor.com