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LSI teams with Impac

Feb 01, 2005

Three common myths about credit scoringSherene Costanzocredit scores, FICO, factors Are you aware of some of the most common credit score myths? Are you giving your clients the most accurate facts about their credit scores? There is so much that is unknown about how credit scores are calculated that it can be a confusing topic. Everyone seems to be discussing what can increase or decrease the credit score. It is important for professionals in the mortgage industry to understand how credit scoring works in order to provide clients with the best possible financing available. Several credit-scoring myths are floating around. Getting the facts can avoid setbacks and have your clients on their way to better credit scores. Myth 1: Closing accounts will increase your credit score This is not necessarily true. Yes, it is true that having too many new credit accounts open can hurt your score. However, closing accounts will not help your credit score and may actually lower it! The damage to the credit score is done at the time of opening the accounts and closing them does not reverse the effects. Credit scoring models actually measure the ratio of your outstanding balances to the amount of your available credit. When you close credit accounts with available credit, your available credit becomes smaller, which calculates a higher percentage of available credit in use. This can actually lower your credit score. For example: Before closing accounts Total balances = $5,000 Total credit limits = $20,000 The percentage of credit in use is 25 percent. After closing accounts Total balances = $5,000 Total credit limits = $5,000 The percentage of credit in use is 100 percent. You should always try to keep this percentage below 40 percent. You may pay down your total balances and close credit accounts simultaneously in order to keep the percentage low. The credit scoring formulas also measure the length of your credit history. Closing accounts can actually cause your credit history to appear shorter than it actually is which definitely will not help your credit score and may actually hurt it. Also, remember that every situation is unique, so if you have had problems with managing your credit, closing accounts may be necessary for long-term benefits, and you may have to take the credit score decrease now in order to protect your future credit rating. If you are currently processing a loan, some lenders look at other factors in addition to your credit scores. The lender may suggest that you close some credit accounts before extending credit to you. Closing accounts, most likely, will not help your credit score; however, it may get you the loan approval you are looking for. Now, it is true that opening too many new accounts can hurt your credit score. Credit scoring models do consider how many recent inquiries are on a credit report. Opening several new accounts may be a signal that one is having trouble obtaining credit or one may be overextending themselves. It is important to be selective when applying for credit so that you keep your inquiries at a minimum. When shopping for home or financing a car, only allow lenders to pull your credit reports only when you are ready and serious about the purchase. When shopping around for best rates, move rather quickly, staying within a time-frame of 30 days or less. Myth 2: Checking your credit report and score will actually decrease your score This statement does not distinguish the method by which your credit report was obtained. Every time your credit is pulled, an inquiry is created on the report. Some of these inquiries may impact the score, but others have no affect at all. Hard inquiries Any time you allow a third party such as a creditor or lender to pull your credit through their sources, a hard inquiry is reported on your credit report. This type of inquiry may impact the score, especially if there are several inquiries over an extended period of time. Soft inquiries Some of your existing creditors check your credit occasionally to evaluate credit standing. They may use this information to offer promotions or even to change the existing terms on an account. These inquiries do not affect the credit score. Personal inquiries When you personally look at your own credit reports and scores, using the three major credit bureaus (Experian, Equifax and Transunion), your score will not change. Actually, it is extremely important for you to check your credit frequently for identity theft and inaccuracies. Correcting any inaccuracies can maximize your score potential. Myth 3: There is only one FICO score There are three major credit bureaus, Experian, Equifax and TransUnion. All three of these bureaus are separate entities and do not share any information. Creditors may report to one bureau or all three bureaus, which could cause each of your three reports to contain different information. Each of these three bureaus offer a credit score based on your credit report with that bureau. This means you have three credit files and three credit scores available. Most lenders and creditors will use the middle score, so it is important for you to pull all three of your credit reports. Monitoring all three reports is significant for improving or maintaining excellent credit scores as well as preventing identity theft. It is extremely important for mortgage professionals to stress the importance of credit to their clients. Knowing the facts allows you to provide your clients with useful information about their credit. It is almost impossible to predict how much one particular factor of a credit report affects the credit score, though manipulating the appropriate factors allows for a better chance of increasing the credit score. Paying bills on time, keeping credit balances low and refraining from frequently applying for new credit is the best way to boost ones score over time. You may also refer your client to a credit consulting company for a more detailed credit analysis that can provide them with the information, education and advice necessary for improving and maintaining excellent credit now and in the future. Sherene Costanzo is the vice president of Credit Consultants Inc. She can be reached at (888) 522-7007 or e-mail [email protected].
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