Archive for the 'Credit Score' Category

If you're about to apply for a home loan and have bad credit, you're probably trying to find ways to raise your credit score before you do. Is there an ideal number of credit cards to maximize your credit score? And is there such a thing as too many credit cards?

A common rule-of-thumb claim is that the ideal number of credit cards ranges from three to eight or more. In reality, the number of credit cards you have is less important than the age of your accounts, your payment history and the amount of debt you carry.

Reason codes and your credit history

FICO credit reports -- FICO being the creator of the most widely used credit scoring system in the U.S. -- contain "reason" or "adverse action" codes that explain why your credit score was lower than the best possible. There are many, many reason codes, and the top four negative factors influencing your score are listed. Here are several:

• Amount on recently opened accounts is too high
• Lack of recently established accounts
• No recent balances
• Length of time accounts have been established is short
• Time since account activity is too long
• Time since account established too short
• Proportion of balances to limit is too high

Codes for "too many accounts" have been abandoned and are no longer in use. One could probably assume from that that having "too many accounts" is no longer a significant factor in determining your credit score.

What's in your wallet?

Determining the best number of cards for your credit profile involves examining your mix of cards. For example, suppose you have five cards, each with $1,000 limits and a total balance of $2,500, on average ten years old. Should you close a couple of cards? Should you open a couple of new accounts? Consider:

• Closing a newer account could increase the average age of your open accounts, which should improve your score.
• However, closing accounts without paying off any of your balances would increase the percentage of available credit used (i.e., increase your credit utilization). While $2,500 of $5,000 total available credit is only 50 percent, $2,500 of $4,000 is 62.5 percent. This could drop your score.
• Opening up a new account has the opposite effect. On one hand, adding available credit without adding to your balance gives you a better ratio of balances to available credit. However, new cards mean a shorter average account age, and a newly established account nearly always causes your score to drop in the short term.

Time off for good behavior

One thing the codes make obvious is that credit is like muscles -- you need to use it or you lose it. FICO likes to see you using your accounts and paying them on time. If you've been good about this, you may be able to get an increase in your credit lines without opening up new accounts. That improves your profile without the credit score dings.

To qualify for an FHA loan, you need to have a credit score (commonly known as a FICO score) above 580. If your FICO score is below 580, you're below the Mendoza line.

Baseball fans will know what I mean by this -- to be considered deserving of a spot in the major leagues, it's widely believed that a player needs a batting average exceeding 200. It's named after shortstop Mario Mendoza, who was considered as incompetent a hitter as should ever be allowed to play major league baseball.

Mortgage lending's version of the Mendoza line is 580. Beneath this score, you cannot obtain mortgage financing from mainstream lenders at decent terms.

So, how do you go about quickly bringing your FICO score above this magical level? Taking steps like closing credit accounts sounds should seemingly help -- but it doesn't. To understand why, dig a little deeper into the world of how credit scores are calculated.

Credit account age and credit scores

It's a myth that closing accounts improves your credit score. If you have an account with derogatory history (bad credit) on it, closing it out does not make that history go away. Only time can do that. What closing accounts will do is shorten your average credit account history length, which is a factor that FICO considers in calculating your score. Moreover, closing accounts also drops the amount of available credit you have, which increases the amount of your debt relative to the credit available to you (known as the credit utilization ratio). A utilization ratio that is deemed too high will lower your FICO score.

If closing accounts makes your score worse, will opening accounts increase it? The answer is no, not in the short term: Opening up a bunch of new accounts does not increase your score either. FICO researchers have found that borrowers with new debt are more likely to miss loan repayments than borrowers who have not opened new accounts. So FICO's scoring model treats new accounts as a negative. In 6 to 12 months, the "newness" wears off, and then the effect of additional available credit may be positive.

Here's the really counterintuitive tip: Paying off really old collections does not help and can actually hurt. That's because the amount of damage a derogatory item does to your score lessens as years go by. When you pay an old collection account, you actually make it a recent event with your new activity and reset the clock on it. What can you do, in this case? Negotiate with the collection agency and get an agreement in writing that the collection will be completely removed from your credit history.

Steps that do increase your credit score

Now that you know what land mines to avoid, what can you do to improve your credit score? Here are some tips:

• Improve your utilization ratio by paying down balances. This is a proven way to improve your scores. It gives the appearance of an improving financial condition, even if you really borrowed the money from your Mom to pay your AmEx. Similarly, Mom -- or another trusted person -- can add you as an authorized user to one of her good accounts, which gives you the benefit of more credit without the liability.
• Set up automatic billpay with your bank. This won't directly improve your score, but paying your bills on time every month builds good credit history. Because the most recent history is the most highly weighted, you'll see the effects very quickly of keeping your nose clean.

Remember, you don't have to be perfect to qualify for an FHA loan. Getting a 580 or better credit score isn't that hard, but there are few quick fixes. Put your strategy into place, then check your FICO every six months until it's high enough to get your approved for an FHA loan.

Do you feel that your mortgage lender has taken advantage of you? Wrongly denied a mortgage modification? Caused you credit problems? A low-budget lawsuit could get your lender's attention without breaking your own bank. Here's what you need to know.

Suing your lender in small claims court

Just because your mortgage lender is a big company doesn't mean you can't drag it into small claims court. It's easy, cheap, and there are no lawyers allowed, so you needn't be intimidated. You can get your case resolved in a matter of weeks, probably a lot faster than you can get a status on your HAMP application.

Understand what you can claim

You need to show how much your lender's actions have cost you, or what needs to be done to undo the damages caused by it. Depending on your state, a judge may be able to order a loan modification, require credit restoration or award monetary damages to you. One homeowner who sued Bank of America was granted a reduction in his mortgage balance by a judge, the lender's punishment for dragging out the HAMP process for over a year and ruining his credit.

How do you file?

Most jurisdictions have similar procedures for suing in small claims court. Here they are:

• Fill out a complaint form and pay a small fee to file it.
• Serve the lender using a process server or certified mail. Lenders are usually corporations or limited-liability companies (LLCs) and you should be able to get the correct address and recipient from your Secretary of State's office.
• The lender is given time to respond (typically 20 days). It may just decide to cut you a check and save itself the trouble of getting spanked in court. If there is no response, you may be able to get a default judgment in your favor. If the lender responds and does not settle, you'll have a trial within 60 days.
• No lawyers are allowed in small claims court, although you can get legal help to prepare your case if you choose,
• The judge will decide the case at the end of your trial or within a few days.

How much can you sue for? Check the limit for your state. Then look up your state's rules; they have different rules about the claims you can make. If your mortgage servicer isn't dealing with you in good faith, stop getting mad and start getting even.

The Washington Post reports that a study by the nonprofit Commonwealth Fund determined that 72 million reported difficulties in paying outstanding medical bills and 28 million were contacted by collection agencies over a two-year period.

The problem is that any collection has a significant impact on credit scores, and credit reporting companies don't distinguish between those that come from something consumers have little control over--billing and payments between medical offices and insurers--and stuff like that bad check to a pizza joint written in an intoxicated haze and blown off for two years.

Should medical collections be treated differently?

Critics say that medical bills are different from other accounts because it's not like we just decide to get sick, as if it was similar to tossing a pair of Jimmy Choos on the VISA or buying a huge-screen before Super Bowl Sunday. Medical collections don't necessarily indicate poor money management.

Data from the National Credit Reporting Association indicates that in extreme cases credit scores can take a hundred-point hit from a collection account--unfair when you understand that many medical collections stem from disagreements over co-pay amounts with insurers or billing issues with medical offices. These offices tend to quickly hand over unpaid or disputed bills to collection agencies, which then report to credit bureaus.

How costly?

Even if you can get a lender to disregard your medical collection and approve your loan, the decrease in your credit score is costly. Fannie Mae, for example, a borrower with a 639 score will pay an extra 3 percent in fees over someone with a 41 point higher score of 480. That's an extra $9,000 on a $300,000 loan because your doc's office got in a spitting contest with your insurance company!

Congress may take action

The proposed bi-partisan Medical Debt Responsibility Act, if passed, would require Equifax, Experian and TransUnion to erase medical collections of $2,500 or less from files within 45 days of their being paid or settled. Today, paid-off collections can remain in files for as long as seven years. The bureaus oppose the bill.

What should you do?

If your credit has been trashed by medical collections but you have been paying your other bills on time, try Federal Housing Authority (FHA) mortgage lenders. There are no surcharges for lower credit scores, but if your score is lower than 580 you would be asked to come up with 10 percent down instead of 3.5 percent down.

In addition, FHA lenders don't look at medical collections the same way they do drunken pizza collections. Bad credit home loan companies are also less likely to care about such things, as are hard money lenders. Try completing the form on this page for a shot at getting approved for a home purchase or refinance.

It doesn't make sense--you'd think that by changing an "open" collection to a "paid" collection, you'd improve your credit score. And that's what a lot of folks do before shopping for mortgages with bad credit. But guess what? In many cases, paying off those collections worsens credit scores.

Why would paying off a collection account worsen your credit score?

The problem stems from the age of the collection account, not the fact that you're paying off a debt. Credit scoring is designed so that the most recent transactions are the most heavily weighted, and your credit history (good or bad) has less effect on your score the older it is. So if your collections are a few years old, their effect on your score has been diminished. When you pay them off or start a repayment plan, bingo! They march front and center right back into the present.

It's as if a new collection account popped up. So unless the collections are quite new, your best bet is to leave them alone so your good deed doesn't give you bad credit. Mortgage lenders can (and often do) make paying off a collection a condition of your loan approval, but you can do that at the title company when you close on your home purchase or mortgage refinance.

Paying off a collection doesn't remove it

The other misconception about collection accounts is that they go away when paid off--normally, they don't; they just show that they have been paid off. Just as a credit card account wouldn't drop from your credit report when you close it out, you can't hide the evidence that you had a debt go into collection.

It's a confusing issue

MyFICO says that "paying old collections won't drop your score," and, "we always recommend paying off your legitimate debts." However, the MyFICO forums are littered with folks who say it isn't so--many claim their scores dropped 50 points or more when they paid off old collections. In any event, no one is claiming that paying off old collections helps your score. There is no reason to do it, unless…

Negotiate a burial

The only way to get fast improvement from a collection repayment is to get the collection agency to agree to remove the account from your credit history (with all three bureaus). You want this agreement in writing--explain to them that you'd like to repay the debt but that you can't chance lowering your credit score. If they agree, pay the debt. Understand that the debt collector cannot remove any negative information about your debt that was added to your credit files when the debt was still with the original creditor.

• How much you will to pay

• How you'll pay (lump sum or over time)

• When the lump sum or payments are due

• How you will make the payment(s)

• That the debt collector agrees to expunge your account from credit reports

• Do not sign the agreement until it reflects everything you agreed to and unless you understand everything in it. When the collection agency returns the signed agreement make a copy for your records.

Once you've paid off the collections, have your lender request a Rapid Rescore (only your lender can do this), and your credit score should go up.

There may not be any shame in being foreclosed on in today's economy. However, credit problems don't just affect home loans, and for people with bad credit, even renting can be a challenge. Competition for rentals is becoming harder as more folks lose their homes, and those with poor credit scores will feel the pinch.

Filing for bankruptcy protection can do some damage to your credit score and put you put of the running with many mortgage lenders. However, bankruptcy can also protect your credit score and help you get a mortgage if you play your cards right. Here's what you need to know.