How do I improve my credit score?Chris Cruisecredit score, determinants, credit report, Fair Isaac, FICO
Credit scoring is quickly becoming one of the most-discussed
topics in the mortgage industry. However, it has recently come
under attack by consumer groups and members of Congress.
Some of the strongest attacks on credit scoring focus on
consumers' seeming inability to change their credit score so as to
change a denial into an approval quickly enough to rescue a deal,
or to keep from having to pay a higher interest rate, since some
mortgage loans are now priced according to a borrower's credit
score. Since the score is based on both positive and negative
information in a consumer's credit report, incorrect information,
especially if that information is derogatory as defined by the
model, can lead to a lower-than-warranted score. And with the
system now in place, correcting and deleting negative and incorrect
information can take weeks. Even after the information is corrected
by the creditor in its own files, the creditor often takes weeks
more to report, via magnetic tape, the new, more-positive
information to the credit repository (of which there are three:
Trans Union, Experian [formerly TRW], and Equifax). But
congressional, regulatory, and consumer pressure are coming to bear
on this cumbersome, paper-based "corrections" system. A credit
industry official recently explained to me that the credit bureaus,
which are local firms that sell reports compiled by the three large
repositories and have the most direct contact with consumers, are
negotiating with the repositories to be able to help consumers make
changes faster. Under the proposal, the local bureau would check
out consumer complaints directly with the creditor and, if the
creditor confirms that the information is indeed incorrect, the
bureau will be able to change the so-called "raw" credit file
directly with all three of the repositories without waiting for the
creditor to check out the complaint, update its files, and then
send the updated information to the repository. This process can
take quite some time, even weeks-long enough to alter a deal. This
is a major development. With the raw file changed, a new, and
perhaps higher, score can be quickly generated and a deal rescued,
so that consumer and congressional concerns may be addressed.
Additionally, the three repositories continue to attempt to
cooperate with each other, in theory sharing any updated, corrected
information about consumers to insure their files are as accurate
as possible. Just to be safe, consumers should make corrections
with all three repositories directly-don't assume anything; they
are, after all, competitors. The three repositories each use a
different version of the Fair Isaac scoring model, but the model
has been adjusted and weighted, so, theoretically, if all three had
the very same information on you, your three scores would be
identical. (A score of 640 at one repository would represent the
same odds as a 640 at either of the other repositories, according
to Fair Isaac.) Of course, not all creditors report to all three
repositories, so even with adjustments, consumers often end up with
three different scores. While it is true that, in theory, you can
have great credit with one repository and bad credit with another,
I have rarely, if ever, seen that happen, although I have seen some
pretty wildly varying scores. In a few cases, I've seen borrowers
with scores that vary by 100 points or more. To combat this
variance, the mortgage industry usually uses the middle score, but
that can be of little comfort to a borrower if they have scores of
550, 570, and 700, and the interest rate for a borrower with a 570
score is two points higher than a borrower who has a 700 score.
Keep in mind that this situation is rare. For example, a borrower
with good credit would have scores something like 685, 702, and
710.
Other new developments include outreach efforts to educate
consumers about credit scoring by conducting seminars and sending
out publications on the subject, in addition to efforts to make
scores more readily available. Federal law says that consumers do
not have a right to see their score, but doesn't specifically
prohibit lenders and creditors from revealing it (the credit report
you can purchase from your local credit bureau does not have your
scores posted-currently, only reports ordered by creditors have
scores). Many in the mortgage industry who know just enough about
credit scoring to be dangerous wrongly believe that they are not
allowed to tell you your score. That may be their company's policy,
but the Federal Trade Commission has made it crystal clear that it
is not illegal to reveal scores to a consumer, while some industry
and consumer groups are now coming out to support the release of
scores. I strongly support the release of scores to consumers, just
as long as the scores are accompanied by information about how the
scores are computed (columns work nicely), so a number isn't just
shoved at a consumer with no context or explanation.
In fact, Fair Isaac has, until recently, opposed the release of
the score to the consumer, fearing that, as the company informed me
in an E-mail, "the nature of credit risk scoring requires that
consumers behave normally (and therefore predictably) when managing
their credit ... if large numbers of consumers receive and
misunderstand their credit risk scores, their short-term behavioral
changes could harm the predictive accuracy of the scoring models
..." Fair Isaac's position is that the expansion of the credit
industry in the 80's and 90's [was] made possible by expanded use
of tools like credit scoring," so anything that hurts the
"predictive accuracy" of the model could make credit less
available. I would acknowledge that some might say that making
credit less available is a good thing!
You may be wondering, just how is a score generated? The
California-based company Fair Isaac (www.fairisaac.com) has created
a complex, proprietary mathematical algorithm. By "back-scoring"
millions of credit files using 33 or more "variables" that are
grouped into 5 categories, from which your credit score is
computed, and then analyzing the performance of those files, the
company found the resulting score to be an incredibly accurate
predictor of future rates of default or late payments. Of those
scoring below the 600 mark, 1 out of 8 would have one or more
90-day late payments. Above 700, that number slipped to just 1 in
123, and above 800 only 1 borrower out of a total of 1,292 would
have one or more 90-day late payments.
The five categories found to be most predictive (with their
relative weighting in parentheses) are:
*Past payment performance (35%): Do you pay
your bills on time? The more recent the late payments, the lower
your credit score. In fact, a 30-day late payment today hurts more
than a bankruptcy five years ago.
*Credit utilization (30%): Have you maxed out your
credit lines? Low balances on a few cards are better than high
balances on one or two cards. Keeping balances below 30% of the
credit line increases your chances for a higher score.
*Credit history (15%): The longer your accounts
have been open, the better, so surfing for a new lower rate on a
credit card and transferring balances can harm your score.
*Types of credit in use (10%): Getting a loan at a
finance company, rather than a bank or credit union, lowers your
score.
*Inquiries (10%): Applying for new credit lowers
your score, but multiple inquiries from the same type of creditor,
such as mortgage companies or car dealers, within 14 days count as
only one inquiry. Promotional or administrative inquiries do not
count against the score-only those times that you applied for
credit count.
It's no secret that Fair Isaac isn't happy about the relative
weightings leaking out, and it contends that the relative ratings
above are not necessarily correct. In an E-mail, a representative
from Fair Isaac told me, "...the numbers change over time. That's
why we periodically update our models and scorecards to account for
changes in consumer behaviors, lender policies, etc."
Now that we know how a credit score is computed, how do you go
about improving it? Certainly, the best way is to pay your bills on
time. You should also keep your balances below 30% of your credit
line, and it's better to keep some small balances on several cards
rather than high balances on one or two cards. Maintain your
accounts for a long period of time. Limit the number of times that
you apply for credit and keep away from finance companies.
What if you have done all of the above and there is incorrect
and derogatory information on your report? Challenge it quickly
with the help of a mortgage professional, and insist that the
creditor correct the information promptly. It doesnt hurt to check
your credit report with a mortgage professional a few months before
you intend to apply for a mortgage. In any case, with the
increasing amount of identity theft occurring, you should check
your credit report at least once annually.
For more information on credit reports and credit scoring, visit
the following Web sites:
*www.creditscoring.com
*www.ftc.gov
*www.fairisaac.com/consumer
*www.homepath.com
At the home site of the National Association of Mortgage
Brokers, www.namb.org, you'll find two extremely informative
brochures that I've seen on the subject of credit scoring-one
brochure for consumers and one for mortgage professionals. You can
also enter "credit scoring" on any search engine and access a
number of message boards and Web sites on the subject.
Christopher Cruise, CRMS, GRML, is a mortgage planner in
Kernersville, North Carolina, and gives credit scoring seminars to
mortgage professionals and consumers. He may be reached at (336)
993-3040.
