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Why is Your Credit Score Important by Levone


									                           Credit Basics
Credit Report vs. Credit Score
Your Credit Scores will affect your ability to obtain loans and mortgages, and will likely affect the
interest rate you pay. Your Credit Scores are based mainly on information contained in the Credit
Reports maintained by the three big Credit Reporting Agencies (CRA’s): Equifax, Experian and

A Credit Report is a summary of various accounts, past and present, opened in your name.
These include credit cards, credit lines, mortgages, charge cards, auto loans, student loans and
other bills. Rent and Utility payments are usually NOT included. Your report will also include any
collection actions taken against you, and any public-record information that may exist, such as
liens, judgments, bankruptcies, foreclosures, etc.

In addition to your Credit Report, each of the CRA’s will calculate and report your FICO (aka
Credit) Score based on, you guessed it, information in your Credit Report. Lenders will often use
your middle FICO score when making their decisions about giving you a loan. When you apply
for a home loan, the lender will usually request your credit report and FICO score from all three
CRA’s and put them together in what some people call a “tri-merge report”.

Getting Your Credit Reports & Scores
As a consumer, you can get a free copy of your Credit Report from each of the CRA’s but not
your FICO scores. If you want these, you will have to pay about $45 for all three. However, if
you are going to buy a house, work with your realtor to select a lender or mortgage broker that
has low fees and points, and have them run your credit. They will pay less than you to get the
information and you can request a copy. At some point they are going to have to run it anyway,
whether you buy it up front or not.

If you’re not yet ready to work with a lender, you can get a free copy of you Credit Report from
each of the major Credit Reporting Agencies BUT they will only give it to you ONCE PER YEAR!
Here’s the link:


You can get your FICO score from my website by clicking on the link labeled “Buyer Tools” and
then selecting the FICO graphic, or simply go to either of the websites below. The cost (and the
source) is the same no matter how you get there.


More about FICO
Fair, Isaac & Company developed a formula for rating people’s creditworthiness back in 1956 and
it has since become the most renowned of all credit scoring agencies. Most lenders will consider
your FICO score in determining whether or not they will lend to you and how much of an interest-
rate premium they will charge you. Your FICO score is a three-digit number ranging from 300 to
850. The higher the better.

Eric Geleynse, Realtor®                                                              3220 Fulton Street
(415) 717-3355                                                                 San Francisco, CA 94118
What’s in Your FICO Score?
This chart shows the weighting of the five major factors that go into the calculation of your FICO
score. Because each of the three CRA’s will have different information about you in their Credit
Reports, they will all end up with slightly different scores.

    1.        Payment History
              This is the largest factor in determining your score. It all comes down to your history
              of making loan and credit payments on-time. Your most recent history (the last 18 –
              24 months) is most important. If you are repeatedly late on credit cards by more than
              30 – 60 days, or on other reported loans or bills, this will have the biggest negative
              affect on your credit. Even worse, if you have collections or “charge-offs” (bills you
              owe but have never paid) then you probably have a very low credit score. If this is
              you, please see my companion document called Fixing Your Credit.

    2.        Amounts Owed
              This measure is most concerned with how much you owe as a percentage of your
              available credit for each account. For example, if you owe $2,500 on a credit card
              that has a limit of $5,000, that is much worse than if the credit limit was $10,000. The
              same is true with student and auto loans. If they are more mature and more “paid
              down” your credit score will be higher.

              One quick boost you can make is to call each of your credit card companies and ask
              for a higher limit. If your payment record is good, they will almost always increase
              your limit, and that will increase your credit score in most cases. (Ask for a big
              increase. They will probably ask you why, so be prepared with a reason. For
              example, some people need to start traveling more for work, which causes them to
              charge more hotels, meals and airline flights on their card.)

    3.        Credit History
              A longer credit history will increase your score. However, you can still get a high
              FICO score with a short Credit History if the rest of your profile shows responsible
              credit management. On the other hand, a short Credit History combined with either
              a poor Payment History or high relative Amounts Owed will be very detrimental
              your scores. The FICO formulas connect these things together.

    4.        New Credit
              Opening new accounts or having many recent credit applications will tend to lower
              your score. The FICO formula takes into consideration rate shopping over a short

Eric Geleynse, Realtor®                                                               3220 Fulton Street
(415) 717-3355                                                                  San Francisco, CA 94118
              period of time as being different from new credit applications over a more extended
              period of time. It’s better to shop for you home or auto loan all in a focused period.
              For home loans, most people do this once they are in contract to purchase.

    5.        Types of Credit
              Having a mix of credit accounts is normal for people with longer credit histories.
              Things like a mortgage, car loan, credit cards, some student loans, etc. This balance
              of credit-line types, all in good standing, will normally increase a person’s score.

Tips for Improving Your Credit Score
In the previous section, under the subtitle Amounts Owed, I revealed one simple way to increase
your credit score. For a more in-depth look at repairing your credit, see my document called
Fixing Your Credit, which you can download from the Buyer Tools section of my website. Here
are a few more tips…

    1.        Closing unused credit accounts that show a zero balance but that are in good
              standing will NOT raise your FICO score. In fact, making a small purchase through a
              long-standing, but seldom used account might actually increase your score.

    2.        On the other hand, having a very large number of credit accounts can be a risk of
              over extension. In this case, closing unneeded accounts may be a good idea for the
              long run, but will probably not give you much of a short-term score boost.

    3.        Making a large purchase that brings you close to your credit limit right at the time of a
              new credit application is bad. For example, if you get into contract to buy a house,
              don’t start your furniture shopping until after your loan has funded. Or, if you want to
              make some large purchases, pay by check, debit card or cash, if possible.

    4.        One near-certain score booster is to pay down some of your installment loans, such
              as student or auto loans, if they are near their original level. For example, an auto
              loan for $25,000 that has a $20,000 current balance, has an 80% balance to loan
              ratio. If you can pay this down by $5,000, the loan will have a 60% ratio. Note that it
              will usually take 30 – 60 days for this type of thing to play itself out through the CRA’s
              and their FICO scoring systems.

    5.        Don’t open a number of new credit card accounts that you don’t need just to increase
              your available credit. This approach could backfire and reduce your FICO score if
              the new accounts are not used and are opened too close to the time you are seeking
              a major new loan.

Credit Reporting Agencies
The three major CRA’s all have good information about consumer credit on their websites. They
will try to sell you a number of services, so remember that you are entitled to receive your credit
report from them once per year for free. (See page 1)

Equifax Information Services             Experian                           Trans Union                         

Eric Geleynse, Realtor®                                                                 3220 Fulton Street
(415) 717-3355                                                                    San Francisco, CA 94118
Traditional Lending Guidelines
In addition to credit scoring, many lenders use what is called the 28/36% rule to determine how
much credit, or what size mortgage a consumer can qualify for. For standard mortgage
programs, most lenders qualify buyers whose total housing expenses [Principle, Interest, Taxes
and Insurance (PITI)] equal 28 percent of their gross income. For example, take your gross
monthly house-hold income, multiply by 28% and that is the maximum amount some lenders use
to determine your maximum PITI payment.

The 36% refers to the maximum amount of debt versus gross income traditional lenders find
acceptable. For people with very good credit, they will go as high as 38%. Car payments,
installment loan payments with more than 10 remaining payments, average monthly credit card
payments, student loans, alimony and similar debts fall into this category. If your monthly house-
hold income is $7,500, the highest monthly mortgage payment you would qualify for using this
formula would be $2,100 (28% of $7500) and the total additional monthly allowable debt payment
would be $600 [(36%-28%)*7500]

Don’t worry if you don’t fit into this formulation. There are many other important factors. The
biggest two are your percentage down payment and your credit score. Practically speaking,
anyone that has 20% down with a FICO score over 700 will qualify for a loan no matter what.
With today’s wide variety of mortgage products, 10% down is usually enough to ensure
qualification with a good credit score. This is certainly true in the Bay Area, where lenders are
use to lending at higher Loan-to-Value ratios, because of the higher cost of housing. However,
what does happen when you don’t fit into the lender ratios is that they end up charging you a
higher interest rate, or you end up needing an expensive Private Mortgage Insurance policy for a
few years.

Consumer Credit Counseling Services

If you have a negative credit history and need help dealing with your debts, you may want to
contact a Consumer Credit Counseling Service (CCCS). This designation is used by members of
the National Foundation for Consumer Credit (NFCC), a not-for-profit organization with 1,450
offices in all fifty U.S. states, Puerto Rico, and Canada. An NFCC member is identified by the
"member NFCC" seal. At little or no cost to you, CCCS counselors will work with your creditors to
establish a repayment plan that will satisfy both you and your creditors. CCCS can also help you
set up a realistic budget and plan for the future. To find the nearest CCCS office by mail or
phone, contact:

National Foundation for Consumer Credit, Inc.
8611 Second Avenue, Suite 100
Silver Spring, MD 20910

Tel: (800) 388-2227

Eric Geleynse, Realtor®                                                            3220 Fulton Street
(415) 717-3355                                                               San Francisco, CA 94118

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