"Bad Credit Credit Card Recommendations"
Ask the Expert— Credit History and Credit Scores Ruth Gaon, CEO Q: Credit scores: we hear them referred to all the time, but many consumers don’t realize how credit scores affect their financial lives. Let’s start with the very basic question: what is a credit score? A: Your credit score is a three-digit number generated by a mathematical algorithm using information in your credit report. It's designed to predict risk, specifically, the likelihood that you will become seriously delinquent on your credit obligations in the 24 months after scoring. Q: Does a person have more than one credit score? A: There are a multitude of credit scoring models in existence, but there's one that dominates the market -- the FICO credit score. According to myFICO.com, the consumer website for the FICO score developer, "90 percent of all financial institutions in the U.S. use FICO scores in their decision-making process." A consumer has three FICO scores, one for each credit report provided by the three major credit bureaus: Equifax, Experian and TransUnion. Since each of the three credit bureaus operates independently of one another, they may have somewhat different information and a slightly different credit score. Unfortunately, consumers currently have access to only their Equifax and TransUnion FICO scores. Experian ended its agreement with myFICO.com in 2009. Q: What is the range of credit scores? A: FICO scores range from 300 to 850, where a higher number indicates lower risk. Q: Why is establishing a good credit history important for the average American, especially in the current economic environment? A: A good credit history is recorded on your credit report which is then used by various companies to make important decisions regarding your future. We are all familiar with the fact that lenders use credit reports and credit scores to help decide whether to give a consumer a loan and how much loan interest to charge. In today’s world, however, we are seeing credit reports used by employers to evaluate prospective employees, utilities to establish rates, insurance agencies to assess the risk of insuring someone and to perhaps assign a higher rate for a person with a less than stellar credit history. Q: What goes into a credit score? A: Data from your credit report goes into five major categories that make up a FICO score. The scoring model weighs some factors more heavily, such as payment history and debt owed. Payment history: (35 percent) -- Your account payment information, including any delinquencies and public records. Amounts owed: (30 percent) -- How much you owe on your accounts. The amount of available credit you're using on revolving accounts is heavily weighted. Length of credit history: (15 percent) -- How long ago you opened accounts and time since account activity. Types of credit used: (10 percent) -- The mix of accounts you have, such as revolving and installment. New credit: (10 percent) -- Your pursuit of new credit, including credit inquiries and number of recently opened accounts. Personal or demographic information such as age, race, address, marital status, income and employment don't affect the score. Q: You mentioned employers using credit reports to evaluate potential employees. As a lot of people are out of work and currently looking for employment, how might this affect the job search? A: Bad credit or even lack of credit could hurt those seeking employment in such a tight job market. One’s credit score may be the “little” detail that makes the difference in landing a job and continuing the search. Employers have become aware of the credit factor, and may be hesitant to push forward with someone who fails to hit the objectives of a good credit score. Q: Given the current economic situation and the tighter job market, how soon should one start building his or her credit history? Should college students add that to their list of responsibilities? A: The college years can be very trying and loaded with distractions, but students need to stay focused on the field ahead, and concentrate on establishing and maintaining a good credit while in college. Recent legislation, while safeguarding students from overextending themselves, could also make building a credit history for young people not as easy as it once was. After years of easy-to-get credit cards for college and even high school students, credit cards companies are no longer allowed to market on campuses. And those younger than 21 must obtain a co-signer or proof that they can make payments to obtain a credit card. The consequence of easy credit has been a generation that had credit card debt before they even had jobs. It’s all too easy for an employer to classify a young person with a bad credit rating as “irresponsible.” Young people should definitely begin to establish credit in the college years, but establishing credit should not be the only focus for young people: maintaining GOOD credit should be the goal. It is important to keep in mind the objective is always to pay bills on time and to make sure that your financial plan ultimately helps you achieve your life goals. Q: But with all the regulations on obtaining credit cards for young adults, how can they start building a credit history? Is there anything parents can do to help their children establish a credit history? A: Since part of one’s credit score is based on length of credit history, parents can help create a credit history for kids well before they even get into college -- and teach a little financial sense along the way. One way is to co-sign a credit card, as Maxine Sweet vice president of public education for credit bureau Experian, did for her sons when they were in college. However, instead of paying the bill herself, she had the bill sent to them. "I have seen so many parents that co-sign a card and pay the bills themselves," she said. "What have you taught kids from that?” Secured credit cards are another option. These cards often carry fees and high interest rates, but are easier to get because they are tied to some type of deposit. Q: Let’s say someone does not currently have any established credit. How can he or she go about establishing a good credit score? A: There are several simple ways to establish credit: Establish checking and savings accounts. Lenders see bank accounts as signs of stability. Opening checking and savings accounts is also one of the few things you can do as a minor to start building a financial history. While you can't get a credit card in your own name until you're 18 and can be legally held to a contract, many financial institutions have no problem letting you open an account. Apply for a major credit card (such as Visa®), and use it responsibly. Pay your credit card bills on time and don’t pay the balance off in full each month. It is important to demonstrate the ability to make monthly payments, on time, for a sustained period of time. Get a cell phone in your name and with your social security number. If you don't qualify for credit on the basis of your own credit file, ask someone with an established credit history (like a parent) to co-sign your application. Remember, the co-signer promises to pay your debts if you don't. Be responsible. Because credit cards make it easy to purchase things now and pay later, it's easy to lose track of how much you've spent. Make sure you pay all your bills on time, and only get the credit cards you need—don't get a card just because the issuer is giving away a cool reward. Q: Obviously establishing credit is the essential first step, but, after that, maintaining that credit in good standing seems to be a challenge for a lot of us. What do you recommend in terms of keeping that credit record in good standing? A: While it is important to initially establish credit, it is even more important to take the time to do the right things to maintain good credit. Here are a few suggestions: Don’t go overboard on the credit cards and loans. They can help with your credit history, but only if you pay them on time. Avoid loans from “finance companies” normally considered lenders-of-last-resort. Loans with these types of lenders do not build credit scores like mainstream financial institutions. Pay bills as soon as they come in. Waiting until they are past due or nearly past due will affect your FICO score. Pay more than the minimum amount due on your credit card bills. Don’t max out your credit card. You may have trouble paying it back and it will reflect poorly on report. Check your credit report on a regular basis. If you see anything that isn’t supposed to be there, or if you suspect your identity has been stolen, act immediately! http://www.annualcreditreport.com/ You are entitled to a free credit report from each of the three major reporting agencies (Equifax, Experian, and TransUnion) every 12 months. The longer you have an account, the more credible you seem. Jumping from card to card will harm your credit scores. Make sure that the credit issuer reports to a credit agency. If it doesn’t, your positive payment history will not be reflected in your credit report. Lastly, take advantage of services your financial institution offers. Through online banking, for instance, you can see your account activity on a daily basis and even arrange to make electronic payments. Q: How much does a specific change affect a credit score? A: The answer is usually "it depends." Credit score developers don't reveal the exact point deductions. The weight of any given activity can also vary for different credit histories. Within a scoring model there's more than one formula used to calculate a score, and each formula is designed for a category of consumers with similar credit profiles. The information in your credit report determines which formula is used. If you are new to credit, for instance, the scoring model will put you into a category for people with young credit histories, and use a scoring formula specific to that group. Such groups are called scorecards. Within that group, recent inquiries may cost more points than they would for a different group. Q: Say someone has some credit cards they want to cancel. Will this help or hurt his or her credit score? A: Closing a credit card account may cause your credit score to fall, although as experts point out, it doesn't have to. Canceling a credit card eliminates the line of credit associated with that account. As a result, depending on your overall debt levels, a key ratio used to calculate your credit score may change. Known as the credit utilization ratio, it compares your credit card balances to the credit limits on those accounts. When you close an account, you may be pushed closer to your credit limits. That can make your score drop, and make you look like a risky borrower. Q: Let’s just say that, due to no fault of their own, someone goes through a bad economic time, maybe due to doctor bills, and they need to know how to repair their credit. Do you have any suggestions for fixing bad credit? A: Yes. Sometimes we lose a job or fall ill and it not only impacts our immediate financial situation but the effects can potentially stay with our credit report for some time unless action is taken quickly. Here are some recommendations in order to hopefully avoid, or at least minimize, the negative effects: First and foremost, examine your current credit report and score. Make sure that everything is accurate. Create a budget. Calculate your income and your expenditures. Find out how much money is going to waste for leisure activities and going out to eat. Then figure out how much money you can set aside each month to whittle down your debt. There is a lot of free budgeting software out there to help you establish a budget. Contact your creditors immediately when your situation changes or becomes unmanageable. Most creditors will work with you to schedule smaller payments that fit your budget (the one that you created in Step 2). After all, they would much rather receive $20 payments for the next year than risk getting nothing in bankruptcy court. This is where having a written budget can really pay off—tell them you’ve worked out a budget, can afford to pay them $x, and offer to send them a copy of your budget. They are much more likely to accept your offer of lower payments if you can show good faith. Get any agreement in writing. If you are able to negotiate lower payments, interest rates, or balance payoffs, request they send a letter confirming it. Having it in writing is your defense against changing minds, lost records, new management being more aggressive, or any number of other things. Once you pay off your debt, make sure you get a settlement letter and send a copy of it to the credit bureaus so they can update your credit report. Stop charging and keep paying at least the minimum on everything. Keep some credit accounts open. When deciding which accounts to keep open, older is better (as long as it also reflects a good credit history). Make all payments on time. Don’t arrange a lowered settlement amount you can’t pay. It will only reflect badly on your credit. Payment history is the number one factor in your credit score—over one third of your score. Avoid bankruptcy if at all possible; it shows up on your credit for 10 years. It takes a lot of hard work and dedication to rebuild your credit instead of declare bankruptcy, but you will be glad you did. Continue to monitor your credit reports with all three agencies as you mend your credit to make sure that all of your efforts are being reflected on your reports.