The world of credit: Establishing credit John J. Hudockcredit scores, credit reporting, consumer behavior Establishing credit has basically been the same for more than 4,000 years. When you borrowed something and paid it back, as you agreed, it was easy to borrow for something else. Since 1899, when they started keeping records, the rules were about the same. Cator and Guy Woolford opened Retail Credit Company in Atlanta, which later became Equifax, the first national credit bureau in the United States. For almost 100 years credit reports were used primarily by business and the credit score, when available, was sold to potential creditors as part of the credit report. Since 1991, the credit score has been developed by the Fair Isaac Corporation (FICO). It is a simplified comparison designed to be a reflection of your past credit habits and your future predictable habits. A credit score is part of a three-digit numerical system. It is somewhere within a range of 350 as the lowest indicator to 850 as the highest. My experience indicates the average score to be about at 640. FICO's Web site lists the average as 723. A credit score of 640 is called a conforming score, which is the minimum necessary to achieve any level of unsecured credit. A score of 720 and above is considered a preferred score and is generally the score required to get you the lowest interest rate a lender has available. A score below 500 is considered minimal or no credit. The most probable cause is a lack of open active tradelines. These are tradelines that have no derogatories (all derogatories consist of late payments 30 days or more). Once a derogatory is placed on any tradeline, it will remain there up to seven years unless removed by the creditor even if the account is paid in full or closed. The most misunderstood impact on credit scores is the lack of credit. In order for a credit score to be in a favorable range, an individual must have open active lines of credit. All current credit-scoring models rely on individuals' past payments to creditors. If you have an insufficient number of these tradelines, your score will be in the 500s or below. If you do not have any open, active revolving tradelines, you will need a minimum of two just to get started. There will be a negative affect on your credit report for recently opened tradelines. After about 90 days, they begin to become very positive. With the score below 640, there is a small chance of anyone getting an unsecured credit card. Unsecured credit cards are credit cards that are issued based on your current credit score with no collateral required. If you are employed, there is a very good chance that you would be eligible for a secured credit card. This is a credit card with a lower high limit, you would likely pay an annual and a monthly fee along with some type of deposit with the credit card issuing bank. If you use these cards correctly, it really would not matter what the interest rate would be, as you should pay off the entire balance every month. If you get a card with a grace period (and I would suggest that you never get a card without a grace period), the interest rate would not be a consideration. If theres no balance, there are no interest charges. When FICO began offering their scoring models to all three repositories, the rules of credit began to change. Paying your bills on time no longer insured that you'd have great credit. You might have good credit, but not the high credit score that you need for lower interest rates. They have interjected new rules. For example: •"Proportion of balance to credit limits is too high on bank revolving or other revolving accounts." •"Length of time revolving accounts had been established." •"The number of inquiries on the consumer's credit file has adversely affected the credit score." •"Too many accounts with balances." •"Number of accounts opened within the last 12 months on revolving accounts is too high." These are actual risk factors that are listed on current credit reports. Some of these are absurd. These factors are mainly related to your income. Also, their score factoring doesnt take into account the differences between someone earning $20,000 a year and someone earning $200,000 a year. The resulting figure improperly shows the proportion of balance to credit limit as being too high. There is different factoring for bank revolving accounts and other revolving accounts. The score also depends on when the credit report is pulled. I have many clients that use their credit cards to create very high balances each month and then pay the balances off completely. Some use as much as $10,000 each month and pay the account down to a zero balance. If any of these credit reports are viewed when the balances are high, it could lower your score by possibly 50 points. At another point, when the balance is paid in full, there would be no points deducted. That could be the difference between a good interest rate and a poor interest rate. FICO has been prejudging individuals. They are penalizing consumers based on predictability formulas. I know many individuals who have high balances on their credit cards, have never missed a payment and probably never will. These individuals are penalized with a lower credit score. In other situations, there are individuals that FICO considers as "Excessive number of revolving accounts." Yet, these people can afford them and never have a late payment. In my opinion, the current scoring system is extremely flawed and totally prejudicial. All comments or information placed on a credit report is at the discretion of the creditor. Only creditors can remove these comments unless they expire under the time limitations set by law. For credit derogatories, the time limitation is seven years; for bankruptcies, 10 years; and for public records, it is also 10 years. Derogatories, public records and bankruptcies do not mean the end of someones credit score. The range goes up to 850 and you only need a 720 to have a preferred credit score. There are 130 points where these negative trade lines could lay. What is important is what you are doing with your current credit. Another consideration is the balance you maintain on any current open active tradelines. The most effective range is a balance below 25 percent of your high limit. If you are attempting to increase your score rapidly, I would suggest that you use your new credit card immediately with a small charge and make a payment to the address listed on the initial correspondence that you received with the card. When you make a payment, it is listed on your account any time your credit is pulled after that date. It will show up as the zero balance, increasing your credit score. I am suggesting credit cards because they report to all three repositories. They are revolving accounts and the easiest account to get listed on your credit report. As I have stated many times, credit cards should only be used to achieve credit and never for a long-term purchases. If you maintain a balance, you defeat the purpose of shopping to save money on an item. If you want additional free information on credit, please try my Automatic Response System by sending an e-mail with the word menu in the subject heading to [email protected] Once you receive the menu, you can choose from the available topics by simply placing the number relative to the topic in the subject field of your e-mail (remember to list only the number and no other wording or quotation marks). John Hudock is president of The International Credit Club and The World of Credit, two companies specializing in credit report problems and scores. He can be reached at (570) 829-5696 or e-mail [email protected] John invites e-mails on any credit topic. He will answer each one and publish any that will benefit his readers. Please be specific with your questions.